6 Why pay low wages?
It is almost tautological to say that firms pay low wages because the marginal productivity to them of the worker is low. There is a vast amount of empirical work done by economists to understand why some workers have low productivity (ie, are paid low wages) while other people have high productivity (ie, are paid high wages). It is clear from this work that the number of years of experience in paid work and levels of formal education are important factors in causing higher wages. Generally, people who have been in the paid labour force longer and/or have more education have higher wages. It is also often true that people who have been with the same employer longer are paid higher wages, although more recent work finds that voluntary movers often have wages higher than stayers. This worker-based perspective does not explain on what basis firms choose to employ a greater or fewer number of low productivity workers.
The positive link between experience and wages is interpreted by labour economists to mean that people learn important skills on the job, formally or informally (see Acemoglu and Pischke, 1999, for a summary). These skills enhance their productivity, and it is this additional productivity that is rewarded with higher wages. Some of the skills learned will only be of value to the current employer, eg, unique work processes, culture or customer details and whether the job is a good match for worker and firm. It is these firm-specific skills that are rewarded by wages that rise with tenure. This standard interpretation is not without its critics. But it describes the empirical regularities well enough and has a coherent, human capital, theoretical base. It embeds the idea that low wage jobs provide the first foot on the ladder. People who start employment without substantial skills learned in the formal education system must learn on the job the skills needed to be a productive worker. Low wages facilitate this learning in two ways. One is that it can be profitable to employ people without particular skills if it is not necessary to pay them very much. The other is that the payment of low wages means that the costs of acquiring skills on the job are borne at least in part by the worker. It is also implicit in this standard human capital formulation that some jobs will not facilitate much upward wage mobility. These are jobs in which the skills required are low level and quickly learned and are not the foundation for further skills development in the firm or the occupation. The fact of being employed is not sufficient to ensure that more than the most basic skills (such as turning up on time and being reasonably reliable) are learned. For early employment to be the beginning of wage progression with experience, some processes must be in place to develop the productive skills of the worker. These may be formal or informal. But the repetition of relatively simple tasks, such as cleaning, will not of itself provide the foundation for upward wage mobility.
The issue to be briefly discussed in this section is what motivates firms to seek to employ workers whom they believe have a low productivity. Which firms, and why, employ new entrants to the labour force who have relatively low levels of education, and employ people who have been out of a job because of unemployment or for family and other reasons?
We know that employers of low skill labour tend to be in the private sector, to be small, and to be in service industries, particularly retailing, personal services and low skill clerical and cleaning services provided to business. But we also know that within quite narrowly defined industries and even occupations, there is a wide variation in the level of wages paid by different firms (Mortensen and Pissarides, 1999).
6.1 Intrinsic to the work
It is fully consistent with standard human capital theory and the assumption of a competitive labour market that some jobs will require low levels of skill to perform, and that the workers who do them will in consequence be paid a low wage. Examples are cleaning, collecting tickets and picking fruit. At a macro level, the number of such jobs offered by firms will be influenced by the pattern of consumer demand, technological change, the technical and regulatory capacity to import low skill-intensive products and services, and the costs of employing low skill labour. It is clear from the diversity among the OECD countries in the proportion of workers who are low paid, that the skill intensity of overall production is not simply determined by technological possibilities. But available technology is relevant. In all OECD countries, low wage jobs are found in similar industries and occupations and this is best understood as being the consequence of shared methods of production.
If parts of a firm’s production process can be performed using low levels of skill, and if the institutions of the economy permit commensurately low wages to be paid, then profit-maximising firms are likely to choose a low productivity/low wage production technology. The interesting empirical question is to understand the extent to which firms have choices about using low skill/low pay technologies as distinct from higher skill/paying alternatives. What proportion of the work performed by low wage jobs is capable of being performed in ways that are higher productivity, and thus would be consistent with paying a higher wage? This is a complex question on which recent work is shedding considerable light. We touch only lightly on this topic because we interpret the questions that motivated this paper to be ones that center on the experience of workers.
6.2 Choice of skill levels in production
While some low wage jobs may intrinsically involve low productivity, others are low wage as a matter of choice by the firm. Technology will determine some of the options available—is there a high productivity technique available? If so, what determines whether or not a firm chooses that path? One set of factors that is relevant is the capital requirements of the alternative technologies. Higher labour productivity is usually the result of the application of more capital (physical and/or human) to the production process. Thus one reason for firms to choose different skill strategies for their labour force is that they face different costs of capital. In particular, small businesses often face greater costs of borrowing than do larger firms, because they are more risky. We can understand part of the observed variation in the use of low wage labour in terms of differences in the costs of complementary factors of production.
But it is likely that in some cases there is simply more than one profit-maximising combination of skill levels and capital that is available to the firm. Some firms choose the higher skill/wage route while others choose the lower skill/wage route. The profitability of these choices will be influenced by how low the costs of employing low wage labour can fall. Lane and Stevens (2001:3) cite a number of studies that lead them to conclude that “—firms, even within quite narrowly defined industries have quite different, and persistent, workforce composition, productivity and turnover patterns.” This important work makes clear that there is not a single profit maximising technology and production strategy that will be adopted by each firm that is in the same product market. (Nor can we rule out that at any moment of time there will be a number of firms that, through incompetence, are employing strategies that are not profit maximising). The conclusion is important because the choices made by firms have substantial impacts on the opportunities that are available to workers.
There is strong empirical evidence that low wage jobs are subject to significantly higher turnover than are higher wage jobs. A firm deciding to use a low wage/skill production strategy must take into account not just the relative costs of capital, skilled and unskilled labour, but also the costs of turnover. Turnover is expensive to a firm because of the costs of hiring and firing and because workers accumulate knowledge on the job that is specific to the firm. A number of studies have noted that the US has relatively low levels of firm-provided training and relatively efficient job matching services and high levels of turnover (Brunello and Medio (2001); Freeman (1995); Blinder and Krueger (1991). The two are believed to be related. That is, firms do not train because they do not expect workers to stay long enough to enable them to obtain an adequate return on the costs of training. It is cheaper to acquire the skills they need from the market, or to use low skill methods of production. The lack of investment in training of workers, and the payment of low wages, in turn encourage workers to quit, which reinforces the low training, high turnover equilibrium.
