Earnings and Capability Requirements

T HERE is more speculation than solid evil dence regarding the role of individual abilities in shaping the personal distribution of earnings. The matter is of obvious political and scientific interest, yet economists have either left most of the work in this area to professions such as occupational psychology and education or have chosen not to deal with it. In most economists' approaches, ability comes in as a variable that might bias the estimate of other coefficients, such as that of schooling, but is not considered essential in its own right. ' This paper takes a different approach. The work reported here stems from a theory developed by the author (outlined in Hartog, 1977), which in turn draws its inspiration from Tinbergen (1956) and Roy (1951). In this theory, the labor market is structured in terms of capabilities, those characteristics of an individual that determine his or her productive potential. Both jobs and individuals are specified by capability levels, which also explain wages. Such an approach is similar to the work on hedonic prices. The hedonics literature usually assumes indivisibilities and inseparabilities in the bundles of characteristics that make up particular commodities (see Lucas, 1977; Rosen, 1974). This precludes arbitrage equating implicit prices and generally leads to unpredictability of the shape of the commodity price function. However, ruling out indivisibilities and inseparabilities leads to the prediction of a linear price equation, which can be used as a standard for empirical work. How can a labor market with a linear earnings equation be modeled? One possibility is given in Hartog (1978); the relevant main features of that model will be repeated. The model is a deliberate choice for a simple operational structure; empirical results should demonstrate any need for modifications and extensions. Suppose capabilities can be measured cardinally (on a ratio scale) and suppose capabilities can be treated as if they were ordinary, homogeneous commodities in the sense of economic theory. Assuming perfect markets, such "commodities" will have a unit price applying to the entire market and earnings will equal the simple sum of all capability earnings. Let individuals command stocks of capabilities and let them have preferences on the utilization of these capabilities in the labor market. Jobs are specified by the required levels of each capability and the individuals evaluate jobs through comparing required capability levels and their available stocks of capabilities. The extent to which they must utilize their capabilities might be interpreted as some measure of effort on the job. This "effort" is the input in a utility function. For example, an individual with high intellectual endowments need not choose a job with high intellectual content; the choice depends on his preferences. The implication for the specification of earnings equations is important: Earnings should not be related to an individual's available levels of capabilities (as is commonly done), but to effectively supplied levels. In the perfect markets assumed here, supplied levels will equal required levels, and hence earnings equations should contain the required capability levels of the individual's job. Linearity of the earnings equation implies perfect substitution of different capability levels in production (homogeneity) in one way or another. One specification of such a production structure is the following. Suppose a cost minimizing organization demands H hours of work in job j per period (a job is a particular set of activities) and suppose that this can be obtained from alternative combinations of total capability amounts (substitution is possible, but imperfect). At given capability prices, there will be some least-cost capability combination yielding these H hours of work j, say c1 units of capability 1 and c2 units of capability 2. Now, let there be perfect divisibility of these total capability demands: the total amounts of capability demanded per period cl and c2 can equally well Received for publication June 28, 1978. Revision accepted for publication March 30, 1979. * Erasmus University. The paper was written while I was visiting at the Institute for Research on Poverty, University of Wisconsin-Madison. It is based on chapter 9 of my Ph.D. thesis (Hartog, 1978). I am grateful to two anonymous referees for some very valuable suggestions. I An exception is Lydall (1968). [ 230 ]