New book

Rethinking Pay in the 2nd Gilded Age

June 24, 2021

What determines the number on your paycheck? When asked, the vast majority of U.S. workers list their own individual performance as a key factor. Large majorities of pay-setters – senior management, human resource directors, and others directly involved in setting compensation rates – likewise believe workers’ individual performance is very important.

I know, because in a series of surveys conducted over the last few years I asked average workers and pay-setters about their ideas about how our wages and salaries are determined. No matter how I posed the question, no factor garnered as much support as individual performance when it comes to our understandings of pay determination in the modern economy.

This belief among workers and employers reflects a longstanding, dominant tradition within academia that likewise views a worker’s individual performance as the core determinant of pay – the human capital model. While many variations of the human capital theory exist, all retain the idea that a worker’s marginal productivity provides the baseline from which to assess his or her pay.

It’s an elegant theory, and one that works best in theory. Research finds that after increasing during the 1980s, jobs with performance-related pay structures peaked in the early 2000s and fell in the following two decades. In a 2009 review of a variety of incentive pay practices, a team of researchers found that “relatively few workers have pay that varies in a direct formulaic way with their productivity, and that the share of such workers is probably declining.” Even among workers whose pay is partly tied to measures of individual productivity, that share is usually a small portion of total compensation.

And as I argue in You’re Paid What You’re Worth and Other Myths of the Modern Economy, a widespread belief in the importance of individual performance to pay blinds us to a set of four organizational dynamics that actually shape the numbers on our paychecks: power, inertia, mimicry, and equity. These forces play out in organizations – in our workplaces.

Fundamentally, all wage and salary determination involves the exercise of power and represents the outcome of past and sometimes ongoing power struggles. Power has the force to settle claims made in organizations over slices of the pie.

Because of this, organizational inertia often prevails: past power struggles legitimize a salary or wage for a particular job over time, which limits our room to negotiate. Organizational inertia is evident when we think of a job as “naturally” paying a certain amount.

Mimicry, where firms simply match the wages and salaries of their competitors, simultaneously simplifies the pay-setting process for employers while assuaging core equity concerns. Paying the going rate in a particular labor market helps stave off workers’ claims that the salary on offer is unfair.

But pay norms change and vary between workers, meaning that employers must always be on alert for disgruntled workers believing they’re not receiving their “fair share,” which can result in lowered productivity among the demoralized employees. 

Accurately accounting for the real forces shaping our pay isn’t simply an academic exercise. It helps us reconsider common understandings and approaches to what former President Barack Obama termed “the defining challenge of our time”: rising economic inequality.

A dominant account of inequality – the skill-biased technological change argument – focuses on changing technologies and the resulting rising demand for skilled workers. Like most workers and pay-setters, the explanation presumes that workers’ pay reflects their individual performance.

From this perspective, rising inequality stems from technological changes outpacing educational attainments. Workers with the means to master new technologies bid up the price of their labor. Those without these in-demand skills are left behind, crowding into bottom-end jobs that pay poorly because of the low human capital needed to perform them.

Yet any explanation of rising inequality in the United States must contend with three fundamental realities of pay in our 2nd Gilded Age: fairly flat earnings for average American workers, runaway gains for the economic elite, and growing pay differences among workers with similar skills and occupations. The skill-biased technological change account or any related explanation of inequality anchored in an individual productivity theory of pay fails this test on at least two fronts.  

First, unless one presumes that our corporate and financial elite’s productivity has skyrocketed relative to the rest of us over the past half century – and there isn’t much evidence it has – then an account for the explosion of top-end incomes must be found elsewhere.

Second, the now well-documented phenomenon of growing pay dispersion among similarly skilled workers, including those in the same occupation, challenges the notion that inequality stems from growing productivity differences between the skilled and unskilled.

Instead, pay disparities have grown in large part because our workplaces are paying similar workers differently.

The fundamental story of rising inequality over the past generation is a massive power shift within workplaces away from employees and toward employers and shareholders. This process has played out unevenly across the organizational landscape, accounting for some of the variation in pay among similar workers we see in the United States today.

My account of pay determination – an account rooted in organizations, with all their power dynamics and established habits, tendencies toward imitation, and equity concerns of people within them, recognizes the many peculiarities and paradoxes we see in real-world wage disparities.

If I’m correct, and workers’ wages are partly function of whether they happened to luck into the remaining “good” employers whose concerns about equity extend to the rank-and-file, then we need to do everything we can to incentivize other employers to mimic the practices of their higher-paying peers.

The same is true if pay derives not so much from individual performance but from broader power dynamics over which the worker has little control. And if pay comes down to the stubborn fact that a worker was discriminated against in an earlier position, and inertia means that initial depressed wage forms the basis of the wage offer that follows, then our efforts must focus on unearthing the original disparity and rectifying the resulting depressed wage or salary.

In none of these cases is it justified to refuse people who work hard the wages that would allow them to live comfortably—or, conversely, to reward with stratospheric salaries those lucky few who have access to all of the key resources that affect pay-setting. We must reject both the unfair punishments and the unfair rewards as equally outrageous.

Read more

Jake Rosenfeld. You’re Paid What You’re Worth and Other Myths of the Modern Economy. Harvard University Press 2021.

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