Wage setting

Recent studies show that even irrelevant relative pay information—earnings compared to the past or to others—significantly affects workers’ willingness to work (labor supply) and effort. This effect stems mainly from those whose pay compares unfavorably; accordingly, earning less compared to others or less than in the past significantly reduces one’s willingness to work and effort exerted on the job. Comparing favorably, however, has mixed effects—with usually no effect on effort, but positive or no effects on labor supply. Understanding when relative pay increases labor supply and effort can thus help firms devise optimal payment structures.

In many developed countries, racial and ethnic minorities are paid, on average, less than the native white majority. While racial wage differentials are partly the result of immigration, they also persist for racial minorities of second and further generations. Eliminating racial wage differentials and promoting equal opportunities among citizens with different racial backgrounds is an important social policy goal. Inequalities resulting from differences in opportunities lead to a waste of talent for those who cannot reach their potential and to a waste of resources if some people cannot contribute fully to society.

Countries with strong industrial relations institutions and well-established social dialogue often perform well in terms of economic growth and social cohesion. The weak and fragmented bargaining and low levels of union coverage in Central and Eastern Europe (CEE) raise concerns about these countries’ potential to maintain competitiveness, tackle demographic and macroeconomic challenges, and catch up with Western European economic and social standards. There is evidence that unions in CEE continue to protect their members and generate wage premiums, despite their institutional weaknesses.

The motherhood wage penalty denotes the difference in wages between mothers and women without children that is not explained by differences in human capital characteristics and labor market experience. As part of the gender pay gap, the motherhood wage penalty can represent a significant cost to being female and having children. If ignored, it may undermine policy initiatives aiming to increase fertility rates in post-socialist countries, such as the costly “baby bonus,” which is a government payment to new parents to assist with the costs of childrearing.

Traditional models of the labor market typically assume that wages are set by the market, not the firm. However, over the last 15 years, a growing body of empirical research has provided evidence against this assumption. Recent studies suggest that a monopsonistic model, where individual firms and not the market set wages, may be more appropriate. This model attributes more wage-setting power to firms, particularly during economic downturns, which helps explain why wages decrease during recessions. This holds important implications for policymakers attempting to combat lost worker income during economic downturns.

Public sector jobs are created because governments opt to provide goods and services produced directly by public employees. Governments, however, may also choose to regulate the size of the public sector in order to stabilize targeted national employment levels. However, economic research suggests that these effects are uncertain and critically depend on how public wages are determined. Rigid public sector wages lead to perverse effects on private employment, while flexible public wages lead to a stabilizing effect. Public employment also has important productivity and redistributive effects.

Gender wage gaps and women’s underrepresentation in leadership positions exist at remarkably similar magnitudes across countries at all levels of income per capita. Women’s educational attainment and labor market participation have improved, but this has been insufficient to close the gaps. A combination of economic forces, cultural and social norms, discrimination, and unequal legal rights appear to be contributing to gender inequality. A range of policy options (such as quotas) have been implemented in some countries; some have been successful, whereas for others the effects are still unclear.

Higher wages increase labor costs but also improve the productivity of the labor force in several ways. If firms take this into account and set their wages accordingly, the resulting wages could fail to adjust demand and supply but may induce phenomena like over-education, discrimination, regional wage differentials, and a tendency for larger firms to pay higher wages. All these phenomena are quantitatively important and well-established empirically. Efficiency wage theory provides an integrated theoretical explanation rather than a sundry list of reasons, and offers an efficiency argument for progressive income taxation.

Low-wage employment has become an important feature of the labor market and a controversial topic for debate in many countries. How to interpret the prominence of low-paid jobs and whether they are beneficial to workers or society is currently an open question. The answer depends on whether low-paid jobs are largely transitory and serve as stepping stones to higher-paid employment, whether they become persistent, or whether they result in repeated unemployment. The empirical evidence is mixed, pointing to both stepping-stone effects and “scarring” effects (i.e. long-lasting detrimental effects) of low-paid work.

The Mincer equation—arguably the most widely used in empirical work—can be used to explain a host of economic, and even non-economic, phenomena. One such application involves explaining (and estimating) employment earnings as a function of schooling and labor market experience. The Mincer equation provides estimates of the average monetary returns of one additional year of education. This information is important for policymakers who must decide on education spending, prioritization of schooling levels, and education financing programs such as student loans.