Zero Marginal Product and the Peter Principle

Tyler Cowen over at Marginal Revolution came up with the idea of Zero Marginal Product (ZMP) workers, people who do some work at their jobs, but not enough to be worth their cost (in salary and other costs), and offers it as a partial explanation of the ongoing unemployment problems of the developed world. This has provoked a certain amount of outrage, the script for which is “how dare you suggest that the unemployed are all lazy.”

Meanwhile, do you know the Peter Principle? The basic concept is, “Peter is a great employee. So he is promoted. He’s great in his new role. So he is promoted. Now he’s management, and he’s not great at management — he’s only mediocre. So he’s no longer promoted, and he stays a manager forever.” There’s some obvious core truth here. I’ve seen people who have been “promoted to the level of their incompetence,” and I imagine you have. But as a principle that purports to have a great deal of explanatory power for working life in America, I’m not sure I believe it. The pyramidal structure of management ensures that lots of people who are good to great in their current role are not going to be promoted, and indeed there seems to be at least some recognition, by both individuals and corporations, that not everyone should be promoted out of jobs they’re great at. In my field, software engineering, there is a career path for people who are great software engineers but have no desire to be managers or executives. I’ve seen multiple people who ended up in management, found they didn’t like it, and arranged to stay with their present company but get out of management.

But isn’t it true that even if we do not all get promoted to the level of our incompetence, we do get raises until we’re at least nearly ZMPs?

In most environments I’m familiar with, raises are everything that promotion into different job duties aren’t. Pretty much everyone gets a raise every year. While you might work five or ten years at a company and never get a substantial promotion (you might get “senior” tacked onto your job title), you don’t work five or even two years without a raise. While some people may reject promotions into management, nobody rejects raises.

And there is some salary level at which we are all ZMPs. I think I’m a very productive worker, but it would be silly for me to ask for $1 million a year in salary.

So the operative question, I think, is what the “profit margin” on a typical worker is. If you are basically an ordinary employee, how much value, in excess of your costs, do you typically create for a company? If the total cost of you as an employee (salary, benefits, the share of office space you take up, whatever) comes to $150,000 per year, do you increase the revenue of the company by $300,000 per year? If so, sure, you have a ton of headroom before you become a ZMP… but doesn’t that also suggest that you’re just underpaid?

If you are not, in an absolute sense, underpaid, then that basically means that you’re already edging up into being a ZMP, right? You’re at least a Low Marginal Product worker.

This is kind of the ugly reverse of commodified markets of goods. In a commodified market for goods, margins are extremely low on each item; the companies making the goods can’t really get a great profit, and that’s wonderful for the people consuming the goods. But if you’re paid “what you’re worth” in an efficient employment market, then you aren’t making your employer much profit, and if, for example, a recession happens and they need to lay people off, they’re likely to choose to lay you off, and it will be difficult for you to get another job at around the same compensation level, because, well… it’s not a huge net benefit to hire you at that level.

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5 thoughts on “Zero Marginal Product and the Peter Principle

  1. I have recently been thinking of how large a multiple the head of a company “should” be paid over the lowest salary paid in that company. Would capitalism still work if the multiple is limited to 10 or 50 or 100 or 1000? In other words, in employee owned companies, should the employee owners limit the top salaries of their executives and insist that further raises echo down the employee chain to the lowest paid employee? What do you think?

  2. Or we could take five minutes to acknowledge something that we seem to have forgotten since Adam Smith wrote it down 238 years ago: The labour market is typified by oligopsony.

    Let’s stop calling these workers ZMPs when they’re ZMRs. Let’s stop pretending the minimum wage isn’t output-and-employment increasing in a really broad range of wage-productivity ratios. Let’s stop pretending that the median American worker (21% of GDP/hour worked today) has somehow become less of an input in GDP per hour than the minimum wage American worker in 1970 (30% of GDP per hour worked then) and let’s stop pretending we don’t know the difference between nominal, real, and faster-than-productivity-growth wage increases.

    Seriously, take a step back and look at your assumptions. If change was skill-biased, I’d expect the vogue policy wonk job of the 1990s, computer programmers, to see their wages outpace productivity growth (they haven’t, with a 25% real wage increase over 20 years while GDP/hour worked rose 45%) or for their field to be expected to add more jobs than the economy as a whole in the next decade (it isn’t).

    Of course, we have seen an increase in subsidies to low-wage employers ala the EITC. Gee, where are the cap-gains-zero crowd when a subsidy is delaying capital formation? We’ve seen a weakening of income supports, and a reduction in wage floors in real and productivity terms. We’ve seen employers institutionalize non-sharing of wage data, and wow do you have to be impressively obtuse not to see that as first-order price discrimination…

    Frankly, I give up with the people destroying Economics with emotionally evocative poors-bashing imprecision-laden phrases like Zero Marginal Productivity, when they know full-well that it conveys a message about the ability and effort of the unemployed far more derisive than “we think they weren’t making the company enough money to justify keeping them on.”

  3. Hi Valerie,

    Thanks for the extensive comment.

    It’s a good point about nominal vs. real vs. faster-than-productivity growth wage increases. I submit that even if real wages have stagnated or fallen, for people consistently employed at the same company for years and years, most expect to see real wage increases every year. The overall real wage stagnation has more to do with people losing their jobs and/or entering the workforce than the consistently employed.

    It’s harder to comment on raises versus productivity growth. We can certainly imagine a world in which someone is consistently given a real wage increases, but their productivity grows to match (or exceed) that each year. We can even imagine a world in which that person’s productivity growth is entirely due to changes internal to that person, rather than say a technological advance which would apply a similar productivity bump to a lower-compensation replacement worker.

    That said, while I can imagine such a world, I’m not convinced that I live in it. I’m not sure I don’t live in it either. I will submit that I regularly see workers who do not, it seems to me, live on a steady ladder of productivity increases. I think much more of a rapid growth and plateau situation. That’s messy and anecdotal, of course, so perhaps we should discount it.

    Finally, you seem rather incensed at the notion that people would come up with a short-hand for “we think they weren’t making the company enough money to justify keeping them on,” but I’ll submit that it’s worthwhile to address the concept of “people who we think weren’t making the company enough money to justify keeping them on,” and that your preferred phrase is simply too cumbersome for useful discussion.

    • Finally, you seem rather incensed at the notion that people would come up with a short-hand for “we think they weren’t making the company enough money to justify keeping them on,” but I’ll submit that it’s worthwhile to address the concept of “people who we think weren’t making the company enough money to justify keeping them on,” and that your preferred phrase is simply too cumbersome for useful discussion.

      I hardly think replacing the word productivity with revenue or profit is too cumbersome for useful discussion.

      • I note for whatever it’s worth that the phrase Cowen came up with is “Zero Marginal Product,” not “Zero Marginal Productivity.”

        But I have no particular attachment to any exact label. I’m fine with “Zero Marginal Revenue” or “Zero Marginal Profit.” Unfortunately, I don’t think that Sandor at the Zoo is quite enough of a tastemaker for me to set what the label “ought to be.”

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