The Case for Higher Wages in Hard Times
January 21 2021 - 10:28AM
Dow Jones News
By Ray Fisman and Michael Luca
Pay cuts and salary freezes have become an unfortunate hallmark
of the Covid-19 recession. Over seven million employees have seen
their wages drop since March, and a great many others have had
their pay frozen. But a handful of companies have bucked this trend
and increased pay despite the economic crisis. In November, yogurt
maker Chobani announced that it was raising its workers' lowest
hourly wage from $13 to $15; the floor was set at $18 in high-cost
centers like New York. E-furniture retailer Wayfair followed suit
last week with a $15 minimum.
These and other companies present such wage hikes as enlightened
capitalism -- a way to help employees during difficult times while
also buying loyalty and goodwill that translate into higher
productivity and lower turnover. It's the latest entry in a
century-old debate over whether companies can improve productivity
and profits by paying their workers more. Economists refer to this
possibility as the efficiency-wage theory: the idea that wages
increased to above market level can effectively pay for themselves
through increased worker motivation and retention. There is
increasing evidence that efficiency-wage proponents may be right:
Higher wages can at times boost the bottom line and -- crucially
for the current moment -- pay cuts can elicit employee backlash and
even sabotage.
The simple economics of efficiency wages were intuited by Henry
Ford in 1914 with his idea of the $5 daily wage -- more than double
the pay at neighboring factories -- for an eight-hour shift (down
from the then-standard nine hours). Ford expected the high wages to
make employees more engaged and harder-working, and if they
couldn't meet his exacting standards, there was a long line of
job-seekers outside the Highland Park, Mich., plant waiting to take
their place.
Modern efficiency-wage theory is more subtle. For example, Nobel
laureate George Akerlof (husband of incoming Treasury Secretary
Janet Yellen, herself a pioneer in the study of efficiency wages)
introduced the notion of "gift exchange": If employers are "nicer"
than they need to be -- by paying above-market wages, for example
-- workers will reciprocate by being more productive than is
required merely to keep their jobs.
Some of the best evidence for the benefits of higher pay appears
in a recently released working paper by Harvard University doctoral
students Natalia Emanuel and Emma Harrington that examined wages
and productivity among warehouse workers at a Fortune 500 online
retailer (kept anonymous in the study). The researchers looked at
the effects of a 2019 pay increase that looks a lot like the ones
recently announced by Chobani and Wayfair -- from about $16 an hour
to $18. Prior to the increase, employees moved an average of 4.92
boxes per hour. A $1 pay increase boosted this figure by a third of
a box. Higher wages also led to a large drop in employee turnover:
a $1 increase reduced the quit rate by 19%.
Given the cost savings from not having to hire and train new
employees, combined with improved productivity, the raise more than
paid for itself, boosting the company's bottom line in addition to
improving employees' lives. The result wasn't only true for
warehouse workers: The study found similar productivity and
turnover improvements from higher wages for the company's customer
service representatives as well.
The win-win of higher wages for this particular company suggests
that pay had been set inefficiently low prior to the 2019 pay hike.
If this mistake could be made by a Fortune 500 business, other
businesses might do well to consider whether they could benefit
from a similar policy.
Other research has found that the impact of pay increases
depends in part on how they are communicated to employees. In work
by one of us published in the journal Management Science in 2016
(with coauthors Duncan Gilchrist and Deepak Malhotra), we set out
to understand why such pay raises have the potential to increase
productivity. In an experiment conducted via the freelancing
platform oDesk (now called Upwork), we found that workers hired for
$4 an hour worked no harder than those hired for $3 an hour. (At
the time, oDesk drew its largest share of freelancers from India,
and both rates in the experiment were high compared to similar jobs
on the platform.) However, giving employees an unexpected raise
from $3 an hour to $4 after they were hired elicited greater
effort.
For managers who are tempted to take advantage of slack in the
labor market to cut wages to the bare minimum, it's worth
considering evidence on the effects of pay cuts. A forthcoming
paper in Management Science by Jason Sandvik, Richard Saouma,
Nathan Seegert and Christopher Stanton looks at one company's
decision to rebalance compensation in a way that ended up cutting
pay for a subset of employees at one division. Other divisions did
not rebalance their compensation at the same time and thus acted as
a "control group" in the study.
The researchers obtained the human resources records of over
2,033 sales agents at the company (again kept anonymous by the
researchers). Consistent with the findings of the Harvard study on
warehouse workers, the authors found that employees who received
pay cuts were more likely to leave the company. More troubling for
company profits, the ones who left had been the most productive
salespeople. So just as higher pay can pay for itself, lowering pay
may have costs that offset much or all of the savings.
A recent working paper by Decio Coviello, Erika Deserranno and
Nicola Persico offered evidence that pay cuts may even lead
employees to be deliberately unproductive. The researchers found
that phone sales representatives at a large U.S. retailer reacted
to a 2014 pay cut by peddling items that customers didn't really
want. How did they know? Because the drop in pay was accompanied by
an increase in sales of items that were ultimately returned for
refunds. Whether it was due to carelessness or sabotage, company
revenues suffered.
Of course, not all firms can raise their wages in 2021. For
businesses that are struggling to stay afloat, like the many
mom-and-pop shops that have been hit hard by the Covid-19
recession, pay cuts may ultimately be the only option. And some
businesses might choose to rely on extensive monitoring or
complicated performance contracts to motivate workers instead.
But when times are tough, it's especially important to think
carefully about both the costs and the benefits of higher wages.
There's been considerable discussion about the moral case for
higher wages, but there is a strong business case as well, since
high wages have the potential to increase productivity and
ultimately profits. In the transition to the new economic normal
after the pandemic, doing what's right may also be what's best for
the bottom line.
--Mr. Fisman is the Slater Family Professor in Behavioral
Economics at Boston University. Mr. Luca is the
Lee Styslinger III
Associate Professor of Business Administration at Harvard
Business School.
(END) Dow Jones Newswires
January 21, 2021 10:13 ET (15:13 GMT)
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