Many people who are not economists think that when we economists analyze people's choices, we assume that "it's all about the money." They're wrong.
First, even when we say that money is important, as we often do, it's not really about the money that you hold in your hand or your bank account. It's about what you can buy with that money. And I don't just mean physical goods — say, a new car or a fancy refrigerator — but also services such as health care or education for your children.
People are often willing to give up money to get other benefits.Second, and more important, we don't think it's all about the money. Money matters, but so do many other factors that affect happiness. We economists believe that there are tradeoffs between money and those other factors and that you can understand behavior by paying careful attention to those tradeoffs. People are often willing to give up money to get other benefits.
This becomes especially clear when we look at the labor market and why people choose different types of occupations or employers. Two examples from the National Basketball Association (NBA) — both involving the San Antonio Spurs — illustrate this point.
Last year, NBA star David West left the Indiana Pacers to join the San Antonio Spurs, where he took an $11 million pay cut (that's right — eleven million dollars!) to play for just the minimum amount allotted to veteran players (still about $1.5 million). It's true that he moved from a state with a state income tax to a state with no income tax, but with that big a drop in before-tax income, his after-tax income still fell by a huge amount.
Why did he do that? The likely reason was that this move would increase West's chances of winning a championship ring, something that NBA players covet and that West hadn't won in his 13-year career. With time running out, he took the plunge.
But West was not the only Spurs player to take a pay cut. Spurs superstar Tim Duncan "slashed his salary in half before the 2013 season, then won his fifth NBA title." And before the 2015-2016 season, he "cut his salary in half again." Why? Because, explains Ben Cohen, that cut was needed if the Spurs were to sign both LaMarcus Aldridge and Kawhi Leonard "to lucrative deals without dipping too deep into the NBA's luxury tax."
The idea that pay from a job is not all that matters applies beyond the NBA to the labor market in general.The idea that pay from a job is not all that matters applies beyond the NBA to the labor market in general. Some workers will accept lower pay if they can get more flexibility about hours worked. Others will accept lower pay if they can have a window in their office. The same reasoning applies to unpleasant aspects of a job. Workers who do dangerous jobs, for example, insist on being paid more to take those risks.
Economists have a term for the pay differentials that people are paid to accept unpleasant conditions in a job: compensating wage differentials.
But the term doesn't describe only the positive differentials for unpleasant conditions. Compensating wage differentials can also be negative, as they were for David West, when workers take a pay cut in order to get a non-pecuniary benefit from a job. People often take lower-paying jobs to live in nice places, to be closer to family, or to do the kind of work that they find most gratifying. Economics professors are a great example. Most of us could make substantially more income as consultants or in business or government. But we are willing to sacrifice some pay in order to work on interesting topics of our own choice, to teach, and to have more control over our daily schedules.
The idea that pay varies with the characteristics of a job is not new. In fact, it dates all the way back to one of the founding fathers of economics, Adam Smith. In his 1776 masterwork An Inquiry into the Nature and Causes of the Wealth of Nations, Smith argues that it's definitely not just about the money, and that all sorts of other factors affect how much money someone will accept to perform a particular job. Smith writes:
First, The wages of labour vary with the ease or hardship, the cleanliness or dirtiness, the honourableness or dishonourableness of the employment.
Thus in most places, take the year round, a journeyman taylor earns less than a journeyman weaver. His work is much easier. A journeyman weaver earns less than a journeyman smith. His work is not always easier, but it is much cleanlier. A journeyman blacksmith, though an artificer, seldom earns so much in twelve hours as a collier, who is only a labourer, does in eight. His work is not quite so dirty, is less dangerous, and is carried on in day-light, and above ground.
Honour makes a great part of the reward of all honourable professions. In point of pecuniary gain, all things considered, they are generally under-recompensed, as I shall endeavour to show by and by.
Disgrace has the contrary effect. The trade of a butcher is a brutal and an odious business; but it is in most places more profitable than the greater part of common trades. The most detestable of all employments, that of public executioner, is, in proportion to the quantity of work done, better paid than any common trade whatever.
In other words, those who take the "dirty jobs" in our society have to be compensated more in order to induce them to do so, and those who take the more pleasant jobs are willing to take less money.
People will take unattractive jobs only if they receive sufficient pay.When Smith and other economists argue that it's not about the money, that doesn't imply that money doesn't matter at all. Indeed, money can be a very large factor affecting why people choose particular occupations: consider the executioner, for example. Just as people will forgo money in favor of attractive non-monetary factors such as winning championships, people will take jobs with unattractive attributes only if they receive sufficient pay to offset the distasteful aspects of those jobs.
What's more, values are subjective: different people have different tastes. Living in Cleveland might be viewed as a benefit to me or LeBron James, but for someone from California, living on the shores of Lake Erie in January just might not carry the same appeal. It's not only money that drives decision-making: many aspects of a job matter.
"How much will a person pay to reduce the probability of his own death?"Economists have expanded on Smith's idea and have used compensating wage differentials to derive important conclusions about human behavior. For example, in his dissertation work more than 40 years ago, behavioral economist Richard Thaler used Smith's work as a basis to ask, "How much will a person pay to reduce the probability of his own death by a 'small' amount?" In other words, what is the wage cut that someone would pay to reduce his risk of death on a job?
After estimating the effects of risk on wages, Thaler and his dissertation advisor, Sherwin Rosen, continued their analysis to suggest estimates for an economic valuation of a "statistical life." Their idea here was that if, say, 10,000 people each insisted on being paid, say, $500 to accept a 1 in 10,000 increase in the annual probability of death, then the value of a statistical life is $5 million (10,000 times $500 each).
Thaler and Rosen specifically identified Smith's arguments regarding compensating wage differentials as the basis for their work, writing that:
Smith's theory has been familiar to economists for almost two hundred years and, in fact, forms the basis for the best recent inquiries into the economics of safety. Yet very little effort has gone into empirical implementation of the idea. Some people have been hostile to it, asserting — without proof — that forces producing observed wage variation are so varied and complex as to preclude isolating the effect of risk. As will be demonstrated below, Smith's logic suggests that the labor market can be viewed as providing a mechanism for implicit trading in risk (and in other aspects of on-the-job consumption) with the degree of risk (and other job attributes) varying from one job to another.
Hence, the idea of compensating differentials forms the basis of many important government and public policy discussions today. For example, should the government improve road safety to reduce fatalities? Using the value of a statistical life, measuring the number of lives saved, and estimating the cost of the safety improvement, one can do a cost/benefit analysis to guide that decision.
So the next time someone tells you that economists think it's "all about the money," you can let them know that it's not just about the money. Money matters and certainly affects human decisions, but it is not the only thing that does.
Economics is about human behavior, not just money.Although David West's income opportunities and choices were extreme, people often give up more pay to get other benefits from a job and often insist on more pay to put up with unpleasant aspects of a job. Economics is about human behavior, not just money.