A long tradition in economics and psychology has advanced the notion that individuals care about not only their own pay, but also their pay relative to that of their coworkers. This has potentially broad implications for wage structure and the organization of labor markets, such as the prevalence of wage compression.
The authors use a field experiment with full-time Indian manufacturing workers over a one-month period to test whether relative pay comparisons affect effort and labor supply. Workers perform individual production tasks, but are organized into distinct teams—defined by the type of product they produce.
The authors randomize teams to receive either compressed wages (where all workers earn the same random daily wage) or heterogeneous wages (where each team member is paid a different wage according to his baseline productivity level). This enables effort comparisons across workers who receive the same absolute wage, but vary in the wages of their co-workers.
The authors find that workers reduce output by 52% when their co-workers are paid more than themselves. They are also 13.5 percentage points less likely to come to work (on a base of 94% attendance) — giving up substantial earnings to avoid a workplace where they are paid less than their peers. These effects are concentrated among production tasks where it is more difficult to observe co-worker output. In addition, effort decreases are larger when the difference in baseline productivity between a worker and his higher-paid peers is small. These findings provide support for reference dependence in co-worker pay, and indicate that transparency about the firm’s rationale for pay is important for fairness perceptions and output.
This may help explain why piece rates—which generate earnings dispersion but are transparent—are not perceived as unfair, while flat wages are often compressed. It also has implications for the types of tasks in which wage compression may be more likely.
This research was funded under the Private Enterprise Development in low-Income Countries (PEDL) Programme
There is also a Working Paper to accompany this Research Paper
Breza, E., Kuar, S., Shamdasani, Y. (2015), The Morale Effects of Pay Inequality, PEDL, 4p