Perceptions of Equity and the Distribution of Income
Julio J. Rotemberg
U.S
NBER Working Paper 5624 June 1996
ABSTRACT
This paper builds a simple model where there is a connection between employees’ perception of the “fairness” of employers and the actual distribution of income. I show that the equilibrium distribution of income depends on the beliefs of employees concerning the accuracy of these evaluations. I give conditions under which the distribution of income across employees of the same vintage is more equal if employees believe that these evaluations are generally inaccurate (so that they are skeptical of capitalists in general) than when they believe that these evaluations are accurate. The model is consistent with the fact that, in a sample of seven countries, the distribution of income is more unequal in countries where people feel that income equality is not too large.
People have opinions about the degree to which the differences in pay reflect differences in productivity. In particular, they have views on the extent to which differences in income reflect, instead, personal connect ions, are the result of favoritism or result from capricious decisions by people with influence, In this paper, I show that opinions of this sort can affect the actual distribution of income even when they do not affect individuals’ abilities. In particular, a change in the degree to which people believe that differences in pay reflect differences in productivity can change the actual income of people even if their marginal product remains unchanged.
My focus on the effects of these beliefs raises the question of where these beliefs come from. In particular, there is the issue of whether people’s perceptions about the degree to which individual income reflects individual productivity shouldn’t be identical to the actual connection between income and pay. In this paper, I allow the actual connection between these variables to differ from the perceived connection and I do this for two reasons.
First, it is very difficult to know what the actual connection between productivity and pay actually is.
The second reason to consider models where the perceived connection between pay and productivity differs from the actual one is that people do not appear to agree on this connection.
Because firms perceive the productivity of different people to be different, they will pay different people different amounts. Indeed, in the case of a frictionless competitive labor market, the wage of an individual is equal to that individual’s marginal product. Opinions about whether people are or are not paid their marginal product do not alter this so that the have no effect on the actual distribution of income.
In the model I present, there are two departures from the assumptions of the standard competitive labor market which ensure that these opinions matter. First, I suppose that a worker’s departure from a firm depends on his outside opportunity and that the firm has imperfect information about these opportunities. The result is that employers have some monopsony power and that wages depend both on the firm’s perception of their employees’ marginal products, and on the firm’s perception of the likelihood that these employees will leave. Second, there are search costs so that workers have to form opinion about what they will be paid on the outside before they leave a firm.
This combination of assumptions yields a simple mechanism by which opinions affect the distribution of income. If workers regard the evaluations of their employers as inaccurate, they are tempted to quit if they receive a low evaluation while they are inclined to stay if they receive a favorable one. The reason is that, if capitalists are inaccurate, it is good to work for a firm that h~ an inaccurately high estimate of one’s own ability. Employees who receive high ratings from their current employers conclude that they have found a good match while those who receive a low rating expect alternate employers to pay higher wages.
Thus, the perception that capitalists have become more accurate makes workers that have received a low rating from their firm more likely to stay (because they now expect a low rating from other firm as well). A monopsonistic firm then tends to cut their wages. Similarly, this change in perception leads workers that have gotten a high rating to be more willing because they are no longer afraid of getting low wages from alternate employers. This, in turn, tends to raise their wages. Since the wages of highly rated employees rise while those of employees with low ratings fall, inequality increases.
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