IMPACT OF WAGES INEQUALITY AND EMPLOYEE PRODUCTIVITY

CHAPTER ONE

INTRODUCTION

1.1 Background of the study

In a perfectly competitive labor market, wage is determined by labor productivity, so wage dispersion reflects the marginal contribution to the revenue product of each worker. According to this theory, treating wage inequality as an independent variable in a model of productivity did not find large consensus, and economists have posed little attention on this potential relation. So, the link between wage and labor productivity is well anchored in economic theory. Higher labor productivity should increase the demand for workers and result in an increase in wages as long as the labor supply curve is not perfectly elastic. Some theoretical models suggest that the causality between the two may also work in the opposite direction. Akerlof (1982, [4]), for instance, argued that higher wages lead to greater effort from workers. More recently, Helpman et al. (2008, [21]) find that greater firm heterogeneity increases unemployment, wage inequality and income inequality, whereas greater worker heterogeneity has an ambiguous effects on wage inequality. However, the literature is sparse regarding studies showing the potential impact of wage inequality on labor productivity.

The existing contributions (mainly theoretical and micro-level empirical studies) do not provide a unilateral answer to this issue: Hibbs and Locking (2000 [22]), for example, do not find empirical support that wage levelling within workplaces and industries may enhance productivity, although reduction of interindustry wage differentials contributes positively to aggregate output and productivity growth. Another strand of literature assumes that managers choose the optimal ‘wage structure” with regard to fairness and cohesiveness, to maximise productivity (Akerlov and Yellen, 1988 [7], Lazear 1989 [26], and Levine 1992 [29]), opening to the possibility that wage inequality may affect someway each workers effort. In this vein, Bandiera et al. (2007, [10]) found that the introduction of managerial performance pay raises both the mean and dispersion of worker productivity, and show that managers target their effort towards high ability workers, and the least able workers are less likely to be selected into employment. So the question is: can be wage inequality a stimulus to work more productively? From one hand, at firm level, Becker (1964, [11]) suggests that greater wage inequality might reduce the incentives to invest in vocational education with possible detrimental effects on productivity growth. Akerlof and Yellen (1988 [7]), Akerlof (1984 [5]) and Cohn et al. (2010, [16]) say that agents who fell under-rewarded tend to supply corresponding fewer effort, and the evidence appears strongest with the provision of services by workers who are led to believe they are underpaid. Rehn and Meidner (1952), Agell and Lommerud, 1993 [1], 2 and Moene and Wallerstein, 1997 [33], claim that squeezing pay differentials between industries and plants could enhance productive efficiency by speeding up the movement of labor and capital from low to highly productive activities.

Levine (1991 [28]) states that “narrowing wage dispersion can increase cohesiveness, and in participatory firms cohesiveness can increase productivity”. At aggregate, country level, Medner and Rehn (1952, [32]) argued that wage solidarity – equal pay for equal works regardless the characteristic of the firm – could raise productivity. Their basic argument was that high wages in low productivity firms or sectors could force them to close, transferring resources to high productivity firms or sectors. Levine (1991 [28]) claims that raising low-end wages can increase national output, as long as the increase in labor costs balances the increase in productivity from higher cohesiveness. At the margin, an increase in low-end wages leaves profit unchanged, but raises productivity, output, and welfare for the low end of the wage distribution. On the other hand, however, Caroli and Van Reenen (2001 [14]) find that an higher ratio of skilled to unskilled pay is negatively associated with organizational changes, which in turn, have a positive association with productivity growth.

Agell and Lommerud (1997 [2]) and Agell, (1999 [3]), claim that compressing wage distribution may reduce the number of low skilled jobs, acting as a signal to workers to invest in human capital, or face unemployment. In this view, the introduction of a minimum wage may lead to a greater human capital accumulation and productivity. Moene and Wallerstein (1997 [33]) provide a theoretical discussion according to which wage compression can raise profitability, increase the rate of new firm entry, and lead to a more modern capital stock (seminal paper by Salter, 1966 [35]). In this paper we test whether wage dispersion may affect labor productivity. To the best of our knowledge, there are not empirical studies which test this hypothesis using country-level data. We empirically test for a panel of OECD countries whether the Gini index of wage inequality (as provided by ILO) has affected or not the average level of labor productivity, for the years 1995 through 2007.

1.2 Problem statement

The concept of productivity of work is divided into two parts: Individual productivity and organizational productivity. Individual dimension associated with the characteristics of the personality characteristics of the individual appears in the form of mental attitude and individual efforts to improve the quality of life. Organizational dimensions look productivity within the framework of the relationship between input and output techniques (Kusnendi, 2003). Aspects of wages becomes important because to be effective if linked to performance for real. An effective wage strategy is expected to contribute on the viability of the unit of work, the realization of the vision and mission, as well as for the achievement of the targets of work (Umar, 2012). Employee productivity measurement using the net value added shows wages and employee performance has a positive correlation, but the rate of growth of net value added per worker is faster than the rate of growth of wages per worker. Means that there are factors other than wages in improving employee performance that is non-monetary factors (Nayak and Patra, 2013).

1.3 Purpose of the study

The purpose of this study is to examine the impact of wages inequality and employee productivity, using manufacturing firms in Lagos State as a case study. Specifically the study:

1. To examine the factors responsible for wage inequality
2. To analysethe relationship between wages inequality and employee productivity
3. To determine the impact of wages inequality and employee productivity
4. To recommend strategies for improving employee productivity.

Related Project Topics :