Sunday, January 24, 2010

All Jobs Pay the Same

Why do plumbers and doctors make similar amounts of money? Why do entry level managers make less annual income than the wage earners under their supervision? Why do CEOs make so much? Why do movie stars make millions when they don't work hard? Why do rock stars get rich when they don't have the work ethic to keep a job at McDonald's? Why do bricklayers make so much now as compared to 20 years ago? All these questions suggest a theory to me which will require a great deal of data crunching to confirm. The theory is this. All jobs pay the same on a risk adjusted basis.

The first element in a person's salary is supply and demand. When demand is great and supply is low, pay increases. For instance, when the internet was taking off in the 90's, IT people made killer money. Then, equilibrium reasserted itself and the pay declined as people rushed in to fill the demand. Meanwhile, blue collar jobs requiring skill saw wage increases as people opted for cushy office work requiring college degrees. The same thing happened in nursing with people choosing less dirty work to do. There is no acute shortage of doctors, but there is a shortage of people to swap bed pans and clean asses. The same thing applies to truck driving. Long haul truck drivers have many job opportunities because people don't like living in a sleeper cab.

People wanting to make good money can go chasing after work that is in demand, but they will end up being disappointed. This was the IT guy back in '04 I was doing work for who was thankful for his $37K a year job with a public utility. I asked him why wages had declined so much and he had one word for me: INDIA. But I think that is starting to change back the other way now. This phenomenon is known as reversion to the mean.

Supply and demand in the job market fluctuates constantly much like the stock market. As variables change so does the job market. The rises and falls in income serve as signals. If a job pays well, it brings in more and better applicants. If a job does not pay well, it attracts less and lower quality applicants. This is how a free market works. An art history major can bitch about making less than a Taco Bell manager, but that is just the way it is. Knowing a Picasso from a Renoir matters less than knowing how many tortillas to order each week.

I tend to slice and dice the job market into four categories:

-Labor
-Management
-Dealmaking
-Ownership

Each job can be delineated by the pay structure. Labor typically works for a wage measured by the hour. Management typically works for a salary. Dealmakers earn a commission or derive a cut from a transaction. Ownership takes their money from earnings. Generally speaking, labor makes less than managers. Managers make less than dealmakers. Dealmakers make less than owners. Owners make the big money. The reason plumbers, doctors, and lawyers make similar amounts is because they tend to be owners. Removed from ownership, they make a pittance. Doctors working in the labor category make a good bit, but you also have to factor in eight years of education and whatnot. On a return on investment basis, those doctors don't make so much. This may explain why those TV doctors rent instead of own.

The biggest factor in large incomes is not so much supply and demand as it is risk and reward. Owners make big money because they take big risks. Part of the reason crab fishermen on Deadliest Catch make so much for blue collar work is because they aren't really laborers but co-owners. They share in the haul for better or worse. This is also why plumbers who own their own businesses make doctor and lawyer type pay. They take the risks, so they deserve the rewards.

It is my belief that if you took all jobs across all my four categories and factored in for risk, they would all pay equally adjusted for risk. Let's consider the fast food worker with the server at Friday's. The server at Friday's makes more because he or she earns tip income. They take a risk that the fast food worker does not. One job is not more skilled than the other. But a server is going to draw more pay because they are being compensated by the fact that the only requirement for tipping is a social one as opposed to a legal one. In a recession, the server has felt a reduction in income as people eat out less and get tighter with their money. The fast food worker cruises along at the minimum wage. In fact, fast food work is probably the least risky job there is. They don't make much, but they are rarely unemployed except by their own choice. The manager of a fast food restaurant is more likely to be unemployed than the guy working on the fries.

Generally, people will not take on a risk unless they are compensated for that risk. This compensation must be greater than the risk free rate of return. This return could be the minimum wage or the amount of one's unemployment check. Doctors make really well but risk massive poverty over the course of their education as they take on debt and live below the poverty line. If they stop one semester short, they will be paying for it well into middle age. I would want a six figure income at a minimum to risk all of this.

Everybody wants to make a lot of money, and the way to do it is very obvious. Take on risk. Become an entrepreneur. Take a job selling real estate. Get on a crab boat. But what if we took a different tack? What if we sought to reduce risk instead of maximizing reward?

In 2007, the median income for US households was $50,233. If we cut this in half, we would have $25,116.50 for a person's individual income. If you make above this amount, consider yourself fortunate. You are in the top half of earners. But if you make only $25K per year owning a store, you are losing money. You are not being compensated for the risk you are assuming because you are earning the average income at well above average risk. This is why most entrepreneurs are better off working for other people.

The best way to reduce risk is to diversify. When it comes to income, the better strategy is not to get the highest paying jobs but to diversify income streams. This would be the schoolteacher who runs a Mary Kay operation on the side and spends summers working in a restaurant. This would be the machinist who serves weekends in the Air National Guard. I know people like this, and I have noticed a few things about them. They earn more because they work more, but they also worry less. It is a rare event that would make you lose two or more jobs at the same time.

A diversified income stream or DIS can be hard to pull off for some people. Some people don't want to work more than 40 hours per week. Other people work crazy schedules that make it logistically impossible. Then, there are family considerations. But for the people who can pull it off, the result should be an above average income at a below average risk.

These are all just theories in my head, and it would take Nobel Prize winning efforts to substantiate them. But anecdotally and viscerally, I believe that all jobs pay the same on a risk adjusted basis, and the best thing you can do is try and reduce your risk exposure through income diversification.

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