Pay and incentives

Higher inequality reduces capital accumulation and increases the informal economy, which creates additional employment opportunities for low-skilled and deprived people. As a result, informal employment leads to beneficial effects on income distribution by providing sources of income for unemployed and marginalized workers. Despite this positive feedback, informality raises problems for public finances and biases official statistics, reducing the effectiveness of redistributive policies. Policymakers should consider the links between inequality and informality because badly designed informality-reducing policies may increase inequality.

Economic theory has many predictions regarding how workers should be paid and how workplaces should be organized. However, economists’ attempts to test these in the real world have been hampered by a lack of consistent information about workers’ productivity levels. Professional sports offer a potential solution, since the performance of individual sportspeople is easily observed and yet many of the same problems faced by managers in workplaces still apply. In many ways, sportspeople may be less atypical of the modern workforce than farm laborers, doctors, or other groups of workers that are often scrutinized by economists.

Economists have for a long time argued that performance-based bonuses raise performance. Indeed, many firms use bonuses tied to individual performance to motivate their employees. However, there has been heated debate among human resources professionals recently, and some firms have moved away from individual performance bonuses toward fixed wages only or collective performance incentive schemes such as profit-sharing or team incentives. The appropriate approach depends on each company's unique situation, and managers need to realize that individual bonus plans are not a panacea to motivate employees.

Employees are more willing to work and put effort in for an employer that genuinely promotes the greater good. Some are also willing to give up part of their compensation to contribute to a social cause they share. Being able to attract a motivated workforce is particularly important for the public sector, where performance is usually more difficult to measure, but this goal remains elusive. Paying people more or underlining the career opportunities (as opposed to the social aspects) associated with public sector jobs is instrumental in attracting a more productive workforce, while a proper selection process may mitigate the negative impact on intrinsic motivation.

When an employer fills a vacancy with one of its own workers (through promotion or horizontal transfer), it forgoes the opportunity to fill the position with a new hire from outside the firm. Although firms use both internal and external hiring methods, they frequently favor insiders. Internal and external hires differ in observable characteristics (such as skill levels), as do the employers making the hiring decisions. Understanding those differences helps employers design and manage hiring policies that are appropriate for their organizations.

Despite equal pay legislation dating back 50 years, American women still earn 18% less than their male counterparts. In the UK, with its Equal Pay Act of 1970, and France, which legislated in 1972, the gap is 17% and 10% respectively, and in Australia it remains around 14%. Interestingly, the gender pay gap is relatively small for the young but increases as men and women grow older. Similarly, it is large when comparing married men and women, but smaller for singles. Just what can explain these wage patterns? And what can governments do to speed up wage convergence to close the gender pay gap? Clearly, the gender pay gap continues to be an important policy issue.

Deregulation and managerial compensation are two important topics on the political and academic agenda. The former has been a significant policy recommendation in light of the negative effects associated with overly restrictive regulation on markets and the economy. The latter relates to the sharp increase in top executives’ pay and the nature of the link between pay and performance. To the extent that product-market competition can affect the incentive schemes offered by firms to their executives, the analysis of the effects of competition on the structure of compensation can be informative for policy purposes.

The escalation in chief executive officer (CEO) pay over recent decades, both in absolute terms and in relation to the earnings of production workers, has generated considerable attention. The pay of top executives has grown noticeably in relation to overall firm profitability. The pay gap between CEOs in the US and those in other developed countries narrowed substantially during the 2000s, making top executive pay an international concern. Researchers have taken positions on both sides of the debate over whether the level of CEO pay is economically justified or is the result of managerial power.

A good boss can have a substantial positive effect on the productivity of a typical worker. While much has been written about the peer effects of working with good peers, the effects of working with good bosses appear much more substantial. A good boss can enhance the performance of their employees and can lower the quit rate. This may also be relevant in situations where it is challenging to employ incentive pay structures, such as when quality is difficult to observe. As such, firms should invest sufficiently in the hiring of good bosses with skills that are appropriate to their role.

Do workplace programs help reduce worker sickness absence? Many programs are based on the principle that the employee’s decision to report an absence can be influenced if it is costly to be absent. Firms can reduce absenteeism by implementing broad programs, including performance pay, general improvements of working conditions, and strengthening workers’ loyalty to the firm. Specific programs, such as grading partial absence, seem to be effective at reducing long-term absences. However, firms will be less inclined to implement such programs if they can shift the financial burden to social security programs.