Fair pay, inequality and economic growth

Does it make sense for a business to pay its staff as little as possible, in order to cut costs and be more competitive, or to raise wages in order to stimulate greater motivation, and gain employee loyalty, thus cutting costs on recruitment and training? In part one of The Price on Inequality on Tuesday, Robert Peston was looking at the widening gap between the highest income earners and the rest of us, arguing that while income and wealth inequality was seen as 'almost a good thing in the 1980's', it is now being seen as one of the greatest economic problems facing us. An article in The New Yorker, 'The Return of Fair Wages', examines a similar theme, looking at a decision by an American company to substantially raise the wages of their lowest-paid employees. Since 2000, 'real' wages in the US have hardly changed, while many US employers are making decent profits and the incomes of the top 1% have risen by nearly 60%. Mark Bertolini, CEO of Aetna (a medical insurance company) has announced that the company’s lowest-paid workers will get a substantial raise—from twelve to sixteen dollars an hour, in some cases—as well as improved medical coverage as part of their package. This article offers some interesting comment on why it may be worth paying employees a little more than the Marginal Revenue Product of their Labour.

Bertolini told the New Yorker's journalist James Surowiecki, “Companies are not just money-making machines. For the good of the social order, these are the kinds of investments we should be willing to make.” (Students reading the article might just question his credibility here when they read later that he made $8bn in 2013....) Surowiecki compares this to the prevailing attitudes in the US in the post-war period, when trade unions were strong and emphasized the idea of the “living” wage—that someone doing a full day’s work should be paid enough to live on. He argues that, at the time of an economic boom in the 1950's, that’s why management guru Peter Drucker could argue that no company’s CEO should be paid more than twenty times what its average employee earned.

He goes on to consider that this sharing of the financial success of a business is not just a case of fairness, but that it also improves both employee retention and productivity, and so is to the financial benefit of the employer in the long run. He gives what he calls "The most famous example in business history" - Henry Ford’s decision, in 1914, to start paying his workers the then handsome sum of five dollars a day. Working on the Model T assembly line was revolutionary in its day; it has the reputation of being the first mass-market production line, making extensive use of Adam Smith’s ideas about division of labour and specialisation in order to get the greatest possible productivity. One result of this was that the workers had very boring, repetitive jobs, and so labour turnover was very high.

And this was expensive: not only the cost of recruiting new staff but also training them actually raise average costs so that the cost and productivity benefits of specialisation start to be lost. Ford’s solution was to pay workers more: “Once Ford started paying better, job turnover and absenteeism plummeted, and productivity and profits rose." This classic example is now 100 years old, but the article brings it up to date as well, quoting just-published research which shows that businesses which pay well, invest in training and give employees some empowerment to contribute to decision making end up with “motivated, capable workers, better service, and increased sales.”

There is evidence here that businesses should not dedicate all their profits to shareholders and managers and just pay workers as little as they can, but that the fruits of their labours should be shared more equally. Does this give us some evidence that higher pay and a more even division of profits might lead to greater growth in the long run?