Date posted: 30/06/2021 5 min read

Why you should pay your staff more

When Henry Ford effectively doubled pay rates in 1914, he and his workers coined it. Why is it worth paying over the odds?

In Brief

  • 68% of surveyed employers in Australia and 43% in New Zealand report difficulty finding suitably skilled staff.
  • Paying more than the going rate creates a sense of mutual obligation that can manifest in positive ways.
  • An ‘efficiency wage’ improves productivity and reduces staff turnover, soon recouping the costs of the higher wage.

Pay increases are pitiful these days, in both Australia and New Zealand. The stats guys compile an index of pay rises on a like-for-like basis – looking at the pay for exactly the same job – and in both countries it’s been dropping for years. There’s a strong cyclical element. In the good times, pre the global financial crisis (GFC), annual pay rises were running at 3.5% to 4%.

But even when the GFC ran its course, and both countries were doing better, pay rises didn’t pick up like they used to. COVID’s twisted the pay screw a bit tighter again.

Annual growth in pay rates (%)Graph: Annual growth in pay rates (%) Click image to enlarge. Source: Donal Curtin with data from the Australian Bureau of Statistics and Stats NZ.

This may be down to our central banks. Neither has managed to get inflation sustainably up to where they’d like it, and if both employers and employees tend to settle on “inflation and a little bit for luck” as a pay model they can live with, it’s no wonder pay rises have been low.

But there’s also something of a puzzle here. Good employees haven’t been that easy to find, and COVID’s border closures haven’t helped. So why haven’t businesses been competing harder for talent? Why hasn’t their bidding against each other driven pay rises along at a faster clip?

How higher wages can help employers, too

You may not feel it’s an issue. Maybe you are one of those employers who posts a job vacancy online and gets 500 CVs back the same afternoon. Good for you. And there are some stats (such as both countries’ ‘underemployment’ rates) that suggest there is still quite a reservoir of available labour to tap into. But that’s not the case for many businesses.

In Australia, according to the March 2021 Business Conditions and Sentiments survey from the Australian Bureau of Statistics (ABS), while most businesses (87%) are happy with staffing levels, 12% are looking to add more people. But when they go looking, “More than two-thirds (68%) of these businesses reported that the main factor influencing the number of employees was the inability to find suitable staff.”

In New Zealand, going by the New Zealand Institute of Economic Research (NZIER’s) latest quarterly survey, “labour shortages are becoming more acute. This is particularly the case for skilled labour, with a net 43% [of employers] reporting difficulty in finding skilled labour – close to levels seen in early 2020.”

If that’s you, and even though every nerve in your profit-maximising body is screaming at you “don’t pay more than the going rate”, maybe you should look at paying over the odds. Not only will you find it easier to get people, but it could well play to your own self-interest in other ways, too. To see why, we need to wander down an obscure avenue of economics that deals with the “efficiency wage”.

The mechanics of the efficiency wage

Originally, the efficiency wage was posed as a solution to a different problem for employers: you can’t easily tell how energetically your staff are working. That guy staring at a screen might be doing some serious strategising, or he might be reimagining last night’s Roosters game.

If ‘shirking’ is an issue, maybe a way to deal with it is to pay a generous “efficiency wage”. Now, if someone goofs off, they’d be at risk of losing what they know to be a cushy number, so won’t chance it.

The characterisation of employees in this model as shirking-prone doesn’t sit comfortably with me: it’s reminiscent of the Soviet era cynicism of “they pretend to pay us and we pretend to work”. Chronic shirking is rare: it’s plain that most people invest themselves in their jobs, and want to do their best.

The subsequent development of the efficiency wage idea takes it into territory that more resembles people’s real motivations.

Paying relatively generously does more than raise the fear of getting fired for slacking. Importantly, it creates a sense of mutual obligation which is likely to manifest itself in a variety of positive ways.

People will do more for employers who they know are treating them especially well: they’ll perform better, and stay around longer. Employers will be inclined to invest more in developing these useful team members.

“People will do more for employers who they know are treating them especially well: they’ll perform better, and stay around longer.”
Donal Curtin

And word gets around. It may be a cliché but the post-Boomer generations are looking for more than the same old nine-to-five. Being known as the Good Guys is a reputational plus in today’s labour market.

Still not sure? Suppose an efficiency wage 10% above the going rate kept employees onboard for longer. At the average earnings level, that will cost you about A$9000 or NZ$7000 a year more than you “needed” to spend. That’s not a lot, set against the benefits of fewer expensive recruitments (especially if you’re one of those 500 CVs businesses).

And that’s just recruitment savings, which are likely to be secondary to the productivity benefits of well-motivated staff. There isn’t a lot of empirical research on what well-motivated staff look like, but the classic example people point to is Henry Ford’s effective doubling of pay rates at his car plants in 1914. Both Ford and his workers coined it.

“Paying an efficiency wage improves productivity and reduces turnover” may just be a fancy-pants economist way of saying “pay peanuts and you get monkeys”, but it looks like it might be right.

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