Tuesday, April 27, 2010

Compensating differentials for status

Economic theory holds that in competitive labor markets, workers are paid the market value of what they produce. In actual markets, pay does rise with productivity, but not by much. The most productive carpenter in a framing crew, for example, might produce twice as much as his least productive colleague, but is rarely paid even 30 percent more. ...

If the most productive workers in a group are paid less than the value of what they produce, why don’t rival employers just lure them all away?

One answer is that these employees may care, often subconsciously, about things besides pay. The most productive workers in a group, for example, often appear to value their status, perhaps because they enjoy greater self-esteem and respect than the least productive workers. To bid successfully for the high achievers, a rival employer might not only have to increase their pay, but also place them in a group where they continue to enjoy a high ranking.

In a free market, however, no one can be in the top half of any group unless others agree to be in the bottom half. And if people prefer not to occupy low-ranking positions, filling these positions would require extra compensation. The rival’s offer, then, would resemble the original pay pattern.

The upshot is that top-ranked workers may well stay put. The high ranking they enjoy is more than enough to offset their sacrifice in pay. Similarly, their less productive co-workers may find it onerous to be at the bottom of the ladder, but they are compensated for that fact by their premium wages.
--Robert Frank, NYT, on why wages are compressed within organizations

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