US Companies Pay Well and Do Better

February 20, 2015

Did Christmas come late? Yesterday, Walmart was the latest major American employer to voluntarily announce a raise for all of its lowest-paid employees. In mid-January, Aetna raised all of its employees' wages to at least $16 an hour. Actually, these companies' initiatives are more rational strategies than gifts of reformed Scrooges. It is possible to profit from paying your employees well—and it is probable that increasing lower-paid workers' wages is the way forward for the United States.

For decades, labor economists have gathered evidence on the power of "efficiency wages." Higher wages can motivate employees to work harder, to treat customers better, make them more reluctant to leave their jobs, and help them to bring fewer worries and distractions to work. That can increase productivity and reduce an employer's costs associated with worker supervision and turnover. Snobbery and current wage disparities favoring the highly-educated should not blind us to the fact that all jobs can be done better or worse, and that lower-paid workers respond to incentives other than just fear of losing their jobs.

It is possible to profit from paying your employees well—and it is probable that increasing lower-paid workers' wages is the way forward for the United States.

This is not just a relative wage story. Of course, companies that move first to raise wages in a given industry or occupational class will attract the better employees out of those available. And companies with reputational problems may improve their standing, and thus their sales, by being more humane. But the productivity impact of reducing turnover and shirking will hold even for the workforces of late adopters.

This is also not just a minimum wage story—though that applies somewhat in Walmart's case. Most minimum wage employees in the United States are the very young, part-time, or sporadically employed. The efficiency wage story is primarily about motivating and retaining the working poor, those who are longer-term employees who want a stable arrangement.

As a result, voluntary wage increases for the lower-skilled could be scalable for a wide range of companies, industries, and jobs. If done broadly, it would involve roughly six percent of the 110 million private-sector workers in the United States—all those paid low but above-minimum hourly wages, and those who work in larger companies where labor is not the only significant production cost.

The Peterson Institute for International Economics estimates that the direct cost to employers of such a widespread wage increase to $16/hour would be only $51 billion, or 0.3 percent of GDP, as compared to the 4.5 percent increase in the capital share of US GDP since 2000. For the six and a half million affected workers, however, that would still represent an increase in pay of over 38 percent, on average. The direct cost to employers, meanwhile, would be offset either entirely or in part by the increase in productivity and decrease in employee turnover—that's why such initiatives are voluntary and would only be applied in industries for which the move makes sense—like the increasingly customer facing Aetna and Walmart.

Not being a Christmas miracle, efficient wage increases will not solve all current economic problems. Fordist fantasies that paying a higher wage would meaningfully stimulate increased purchases, for example, have to be left aside, with the numbers involved too small to move aggregate demand much. Nor will such initiatives take the place of needed training to make sure workers have the proficiencies to take advantage of the job opportunities that arise—motivation is no substitute for technical skills. The shortfall of long-term investment in the United States, public and private, cannot be made up for with low-skilled labor.

Yet, private sector leadership in increasing wages for the low-skilled will have a far greater beneficial impact than the government legislating a higher minimum wage (though I support that, too, for simple human reasons). It will benefit more workers and, because it will encourage higher productivity, it will have little or no cost in reduced employment. That may explain why countries whose lower-skilled workers are paid relatively better have higher (not lower) employment rates. As it will be undertaken voluntarily, it will be implemented only in those companies and industries where it makes sense for productivity. Most of all, it will increase the dignity and security of workers as workers directly, whereas post-tax redistribution can only improve income. We should encourage and expect more US companies to start doing well by paying well.

The author is president of the Peterson Institute for International Economics. This article draws on the Institute's work on Inequality and Inclusive Capitalism, which is supported by a major grant from the ERANDA Foundation.

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Adam S. Posen Senior Research Staff