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Bonuses lead to more wage inequality
Thomas Lemieux strikes again:
An increasing fraction of jobs in the U.S. labor market explicitly pay workers for their performance using a bonus, a commission, or a piece rate. In this paper, we look at the...growing incidence of performance pay on wage inequality. The basic premise of the paper is that performance pay jobs have a more competitive. pay structure that rewards productivity differences more than other jobs. Consistent with this view, we show that compensation in performance pay jobs is more closely tied to both measured (by the econometrician) and unmeasured productive characteristics of workers. We conclude that the growing incidence of performance pay accounts for 25 percent of the growth in male wage inequality between the late 1970s and the early 1990s, and for most of the growth in top-end wage inequality (above the 80th percentile) during this period. This economist deserves...um...a bonus.
Posted by Tyler Cowen on January 11, 2007 at 06:44 AM in Economics | Permalink
Comments
Interesting, what would it say for fairness if most of the equality of wages was the result of free loading on the star performers?
Posted by: nelsonal at Jan 11, 2007 8:26:43 AM
nelsonal, this is interesting. It would say, if empirically true, in my opinion, that this is a positive statement, not a normative one.
If true, this is simply an indication that there may be* tradeoffs between equality of lives(economically) and overall economic productions. It does not offer much in terms of where to draw the line on those tradeoffs.
Tyler's argument, and the prevailing view on this site is that growth trumps all. The majority of people disagree on that point. Tyler provides about as good an argument in general on this site for why growth should be given importance.
*It does not tell us much about more macro effects that inequality might have, for example, an increase in the prison population that would reduce productivity.
Posted by: theCoach at Jan 11, 2007 8:54:23 AM
i never cease to amazed by the really fascinating work many economists keep producing. good research is a public good.keep it coming.
Posted by: sa at Jan 11, 2007 9:46:21 AM
I thought that the purpose of bonuses in lieu of a regular steady paysheck was to make it harder for workers to quit... that would mean they'd lose their year end bonus.
Posted by: Half Sigma at Jan 11, 2007 9:59:32 AM
I didn't read the whole paper, but searched for "tax" and didn't get a hit. They might want to take into account the fact that there is an incentive for employers to pay in part with a bonus rather than entirely with regular wages: a bonus can be deducted (for tax purposes) in the year prior to which it is paid if it is timed properly; regular wages can only be deducted in the same year that they are paid. So the assumption that bonuses are used to tie more closely to productivity might not be as strong as you'd think.
Posted by: beedubs at Jan 11, 2007 10:19:52 AM
"compensation in performance pay jobs is more closely tied to both measured (by the econometrician) and unmeasured productive characteristics of workers"
If this is true, doesn't it mean that inequality is a just result?
Shouldn't we be paying more productive people more?
It would seem that in the past, equality was greater in income, but much less just. Less productive work was rewarded more highly.
Posted by: Ivan at Jan 11, 2007 10:36:06 AM
It seems that this is something that all economists should favor. Inequality drives productivity (people want to earn more, so they work harder, train, etc) and the very best form for that inequality would be that form most directly connected to performance - i.e. performance related bonuses.
Posted by: liberty at Jan 11, 2007 11:08:54 AM
The biggest potential problem is if there was an unanticipated regime shift. So imagine that giant company X used to pay all workers on the following implicit rule/norm: Bonuses will not be so high but extra work now will lead to better pay with seniority even if you're not a superstar and even if your productivity is actually slightly lower later.
Suddenly the system shifts and you're told -- it's all current-market driven now and you're on your own. What have you done for me lately? Then this becomes an ex post contract violation that is not punishable.
This is not a criticism of free markets, this is about the unenforceability and critical role of implicit contracts in wage hierarchies in the presence of changing economic conditions.
Posted by: jn at Jan 11, 2007 11:38:53 AM
"25 percent of the growth in male wage inequality between the late 1970s and the early 1990s"
I happen to work in a field where the strong producers are women - I wish they had done an analysis of Realtors and Mortgage Bankers' compensation from 1970 to 1990 who are typically paid 100% commission. Women do quite well in this field. It's been said that purchasing a house is an emotional decision. Many of these saleswomen connect quite well on the psychological aspect of making the sale especially when it is a face-to-face transaction.
Posted by: candi at Jan 11, 2007 12:10:01 PM
The naked economist has an article on yahoo finance about this -
http://finance.yahoo.com/columnist/article/economist/19750.
His argument is that inequality matters because if the gap becomes
to wide, people could feel that there is no way to make progress up
the salary ladder. He combines this with recent research that people
have more esteem for relative than absolute wealth.
Posted by: adam at Jan 11, 2007 1:19:03 PM
I have been in finance all my life and am a big fan of bonuses. At my last job, the bulk of my pay was salary, but I also received quarterly stock options and cash bonuses. At a big company, once you get on the gravy train (which is where hard work comes into play), it is near impossible to get off of it. What I learned is that titles are extremely important because they provide the ranges of your discretioniary income (eg. no VP could ever get 10,000 stock options in one quarter, but an SVP could; only VPs and up are eligible for quarterly bonuses). Also, those bonuses did not vary as much as your salary could year to year regardless of how the firm did (typically 65% base, 35% bonus). All of this changes, as everyone knows, as you move up the ladder.
At my current job with a small firm, my salary will never change, but my bonus can vary wildly depending totally on the firm's performance (25-50% base,50-75% bonus). So I live like Clark Kent for most of the year and then Superman for a few weeks before I put most of it back in the bank. I get my bonus this April for 2006 - light a candle for me.
Posted by: Patinator at Jan 11, 2007 2:23:57 PM
I'll look it up again at the bls.gov site, but the average production worker makes something in the neighborhood of $13.50 an hour, on average. The avg union production worker makes around $15, and the avg production guy getting paid via piece work, makes somewhere north of $19.
When I taught high school science, this little example was useful in explaining a number of things about human behavior.
Posted by: Ray G at Jan 12, 2007 11:12:25 AM
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