MPACT OF WAGES INEQUALITY AND EMPLOYEE PRODUCTIVITY
CHAPTER TWO
LITERATURE REVIEW
The Concept of Wages
One purpose of a person as an employee of a company is to earn income in the form of wages or compensation. Received wages to meet basic needs such as food, clothing and housing. Every company in determining the amount of wages paid to the employee must be feasible, so that the lowest wage that is given to meet the needs of their life (Kanzunnudin, 2007). Some economists opine about the meaning of wages. According misesian view that the increase in employment opportunities can only happen if the workers receive wages lower nominal (Syahdan, 2007).
Implicit contract model briefly demonstrated that the wages of workers in a company is determined by the contract between the employer and the union. This means that in the presence of strong unions, wage rates can not be easily changed as in a perfectly competitive market. Resulting in wages rigidity and especially wages will be extremely diffi cult to decrease if there is a recession.
According to this theory the company tend to set wages higher than perfectly competitive market equilibrium wages. Insider-outsider models considers that the markets for goods and labor markets are imperfect. If the labor market there is a union and a relatively limited number of enterprises, the wage rate is determined from the collective contract agreements between unions and employers. Union members called insider and who are not in a union called the outsider. wages determination with the contract likely to be higher than was the case in a perfectly competitive market.
Wage flexibility is the main topic of the economy, are mostly found in the literature related to the provision of incentives provided by the company. A number of theoretical models have developed an explanation of how the company should design compensation schemes to encourage employees to work for the benefit of the company. The conclusion is put some effort into their work to maximize corporate profi ts (Prendergast, 1999).
Wages become an important aspect of being effective if linked to the performance signifi cantly (Umar, 2012). Granting wages remuneration is the most complex task for the industry, is also the most signifi cant aspects for workers, because of the amount of wages refl ects the size of the value of their work among the workers themselves, their families and communities. Wages are very important for the industry because it refl ects the industry’s efforts to defend human resources in order to have a high loyalty and commitment to the industry. Effective wages strategy is expected to contribute to maintaining the viability of the work force, the realization of the vision and mission, as well as for the achievement of work objectives (Umar, 2012).
2.2. Quality of Work Life
The term quality of work life was first introduced at the International Labour Conference in 1972, but recently gained attention after the United Auto Workers and General Motors took the initiative to get the job enrichment and wider opportunities for self-development. So as to encourage employees to further develop itself (Arifi n, 2012).
Perspective of cultural change in many organizations working life is currently connected to the various terms such as quality of work life, culture change programs, fl exible work arrangements, employee relations, and reduction of workload (Harrington, 2007). Moreover, the focus of the fl exibility of working life into the workplace is to respond to the needs of women who work outside the home.
Currently, extended working life touched all aspects related to the life of a person’s job, for example recruitment, taking leave, the composition of the team work, corporate social responsibility.
There are two opinions regarding the intent of the quality of work life. The first opinion says that the quality of work life is a number of circumstances and practices of the company’s goals, for example: Promotion policies, democratic supervision, employee involvement and safe working conditions. While others claim that the quality of working life is employees’ perception that they want to feel safe, relatively satisfi ed and get a chance to be able to grow and develop properly human (Arifi n, 2012).
The concept of quality of work life reveals the importance of respect for human beings in the work environment. The important role of the quality of work is changing work climate that is technically and humane organization brings to the quality of work life better (Arifi n, 1999). Measurement of quality of work life will have an impact on increasing the positive attitude of employees towards their work and to the company, increase productivity and intrinsic motivation of employees, increase the effectiveness of the company and the company competitive in the face of global business (Tjahyanti, 2013).
Human resources is a factor that is very valuable. The company is responsible for maintaining the quality of work life and fostering labor to be willing to contribute optimally to achieve its goals (Pruijt, 2003).
The role of the human resources department has a major contribution in setting the strategy of the workers. Good quality of working life will create productive human resources, qualified, committed and dedicated to the job, which in turn can improve employee performance (Haryati, 2012).
Employee Productivity
One of the key issues that most organizations face nowadays is the need to improve employee productivity. Employee productivity is an assessment of the efficiency of a worker or group of workers. In actual terms, productivity is a component which directly affects the company’s profits (Gummesson, 1998; Sels et al., 2006). Productivity may be evaluated in terms of the output of an employee in a specific period of time. Typically, the productivity of a given worker will be assessed relative to an average out for employees doing similar work. It can also be assessed according to the amount of units of a product or service that an employee handles in a defined time frame (Piana, 2001). As the success of an organization relies mainly on the productivity of its employees, therefore, employee productivity has become an important objective for businesses (Cato & Gordon, 2009; Gummesson, 1998; Sharma & Sharma, 2014).
Many studies have focused on one or two ways to measure productivity and since many different approaches are taken, it can be challenging to compare the results (Nollman, 2013). Overall, there is a lack of an effective and standardized way to assess productivity. According to Sharma and Sharma (2014), employee productivity is based on the amount of time that an employee is physically present at his/ her job, besides the extent to which he/ she is “mentally present” or efficiently working during the presence at the job. Companies should address such issues in order to ensure high worker productivity.
Ferreira and Du Plessis (2009) indicated that productivity can be evaluated in terms of the time spent by an employee actively executing the job he or she was hired to do, in order to produce the desired outcomes expected from an employee’s job description.
Previous literature has clearly discussed the advantages of employee productivity which would lead to organizational success. According to Sharma and Sharma (2014), higher productivity results in economic growth, higher profitability, and social progress. It is only by increasing productivity, employees can obtain better wages/ salaries, working conditions and larger employment opportunities.
Cato and Gordon (2009) also demonstrated that the alignment of the strategic vision to employee productivity is a key contributor to the success of an organization. This alignment as a result would motivate and inspire employees to be more creative, and this ultimately can improve their performance effectiveness to accomplish organizational goals and objectives (Morales et al., 2001; Obdulio, 2014).
Moreover, higher productivity tends to increase the competitive advantage through reduction in costs and improvement in quality of output.
The above discussion has clearly discussed the concept of employee productivity. It indicates that employee productivity is a key determinant of organizational profitability and success. In the following section, work engagement as key human resource practice and its effect on employee productivity is presented.
Work Engagement
Employee work engagement is one of the main business priorities for organizational executives.
According to McEwen (2011), engagement depends on employees’ perceptions and evaluations of their working experience, including their employer, organizational leaders, the job itself, and work environment. Echols (2005) advised that in order to enhance employee engagement, managers should
pay attention to the skills, knowledge and talents of their staff. The author added that when employees are aware of their strengths and talents, their level of engagement will be higher, and this ultimately leads to better performance. Rothmann and Storm (2003) demonstrated that work engagement can be reflected through the energy, behavioural satisfaction, efficacy and involvement. Swaminathan and Rajasekaran (2010) also concluded that engagement results from employee satisfaction and work motivation.
Several definitions of employee engagement exist in the literature. Fleming and Asplund (2007, p. 2) describes employee engagement as, “the ability to capture the heads, hearts, and souls of your employees to instil an intrinsic desire and passion for excellence”. Certain scholars also viewed employee engagement as a construct which consists of cognitive, emotional, and behavioural elements that are related to the role of employee performance (Shuck et al., 2011). It reflects the commitment and involvement of an employee towards his/ her work that is aimed to improve organizational performance (Sundaray, 2011). Furthermore, Bakker and Demerouti (2008) defined engagement as “a positive, fulfilling, work-related state of mind that is characterized by Vigor, dedication, and absorption”.
According to Bakker and Demerouti (2008), Vigor can be described in terms of an employee’s levels of energy and the mental resilience while doing his her work. Shirom (2003) indicated that Vigor refers to the mental and physical health of an employee. On the other hand, Harpaz and Snir (2014) expressed dedication in terms of being highly involved in the work and is reflected through the feelings of enthusiasm, challenge, and significance. The other dimension of work engagement which is known as absorption was previously described by being fully focused and happily attached in one’s work, whereby the employee feels that time passes quickly and has difficulties with detaching himself from work (Truss et al., 2013).
Employee engagement is a key organizational issue that should be strictly given enormous consideration by organizational management in the current scenario of challenging business environment (Saxena & Srivastava, 2015). This is because highly engaged and motivated employees reflect the core values of the organization, and this resultantly reinforces overall brand equity (Ramanujam, 2014). The review of literature reveals that engaged employees yield positive organizational outcomes. In the rapidly changing markets, business leaders recognize that highly engaged employees can increase their productivity and firm performance (Bakker & Demerouti, 2008; Markos & Sridevi, 2010). In other words, engaged employees feel passionate about their work, happy to work in their organization, and have the enthusiasm to go to their work every day (Ramanujam, 2014). Besides that, employees who are engaged in their work are deemed very important for their organizations in maintaining competitive advantages; coping with changes, and ensuring work innovations.
Past studies (Abraham, 2012; Anitha, 2014; Echols, 2005; Haid & Sims, 2009) found that work engagement had a significant positive effect on employee productivity. According to Zahargier and Balasundaram (2011), a successful and highly productive business can be achieved by engaging its employees in improving their performance. Similarly, Harter et al. (2002) conducted a meta-analysis of data on 7,939 business units from 36 firms that represent different sectors and found out employee engagement had a significant positive impact on increased productivity. In line with the study of Markos and Sridevi (2010), employers should consider investing in workforce engagement because it has a positive impact on performance outcomes such as employee productivity.
Employee Performance
Measurement of employee performance is an activity that is very important because it can be used as a measure of success in supporting the success of the organization’s employees (Said, 2008). Factors used in the measurement of labor productivity include the quantity of work, quality of work and timeliness (Simamora, 2004). Individual characteristics that affect performance include age, gender, education, length of employment, job placement and work environment.
Performance is influenced by two factors: Factors of self-acting self and external factors acting. Factors that is in the position holders are competence, skills, knowledge, motivation, attitude and experience. External factors are environmental organization office holders, including surveillance, communication, training and performance assessment in an organization. Human productivity has a major role to determine the success of the company. Human productivity is often referred to as mental attitude always had the view that today is better than yesterday and tomorrow.
Other factors are quality of work that consists of working environment safety, Employee engagement, problem solving, career development, pride, communication, and facility to mediate the relationship between wages and performance.
CONCEPTUAL FRAMEWORK
The increase in the minimum wage set by the government requires companies to adjust remuneration according to the rules and regulations that apply to their employees. Changes in the wage structure does not guarantee an increase in employee performance and make employees feel comfortable in working.
Many things can be done by the management company for the performance of employees is increasingly rising. Through this form of compensation and human resource development to be a view that is important for the company and employees.
Self-esteem can be a mediating variable between salaries influence on performance, but only useful as a partial mediating variable, it is due to a direct effect on the performance of a larger salary than through self-esteem (Ertanto and Suharnomo, 2011). Work motivation, job satisfaction and wages signifi cant effect on worker performance. Partially there is impact on the performance of the employee salaries, allowances are no significant influence (Umar, 2012).
There are factors other than wages that affect employee performance is the quality of work life. There is a relationship between the quality of working life with employee performance and career development is the most dominant factor (Haryati, 2012). The results showed that the better the quality of work life of employees affects the performance. The higher the feeling satisfied employees will motivate against the spirit of performance (Arifi n, 2012).
Relationships intrinsic motivation, extrinsic motivation and performance of generating different opinions by several researchers. Failure incentives to improve performance proves that the wages is not a motivator. Employees who managed to do his job very well do so not just to earn money but because they like to do (Aisyah, 2006). A similar argument shows empirical evidence on differences in better performance in subjects who are interested in the task and got fi xed compensation, compared to subjects who received incentive-based compensation (Arniati, 2012). Other research results stated conditions opposite of extrinsic motivation (salary, status, social security, supervision and company policy) a significant positive effect indirectly to employee performance through job satisfaction as an intervening (Muslih, 2012). Extrinsic motivation is also signifi cant direct positive effect on employee performance. Intrinsic motivation (achievement, recognition, responsibility, promotion and job suitability) signifi cant positive effect indirectly to employee performance through job satisfaction as an intervening, but no significant effect of intrinsic motivation directly to employee performance.
How wage inequality affect productivity growth?
The established theoretical literature on wage determination provides rather little guidance on the likely implications for comparative historical productivity growth of variations in wage inequality. It is far from clear what a simple notion of a perfectly competitive labour market in which factors of production are paid their marginal revenue products would lead one to expect, even with regard to the level of productivity (Hibbs and Locking, 2000).
A more recent theoretical literature has firms, or more strictly managers, choosing an optimal wage structure with some regard to fairness or cohesiveness (e.g. Akerlof and Yellen, 1988, Lazear, 1989, Levine, 1992). If firms, or managers, always decide optimally, however, it appears difficult to divine any predictions on the cross-national relation between wage inequality and productivity, still less wage inequality and productivity growth. If there is any prediction at all, it appears that it is that there will be no relation. It might simply be thought that wage inequality represents an incentive to work; an incentive for employees to accommodate themselves to the demands of their employers in the hope that they might earn more, or avoid earning substantially less. Similarly, the elementary human capital investment approach appears rather clear cut in its implications, with Becker (1964) suggesting that a compression of the wage distribution would reduce the incentives of individual employees or potential employees to invest in vocational educational and training to develop their human capital, with possibly detrimental implications for productivity growth.
The simple incentive effect on human capital accumulation, however, is not the only possible implication of wage inequality. Since compressing the wage distribution is likely to reduce the number of very low skilled jobs, this may act as a signal to workers to pursue human capital investment, or face unemployment. Thus, for example, the introduction of a minimum wage may lead to increased human capital accumulation (Agell and Lommerud, 1997, Agell, 1999). The extent of wage inequality may also affect the uncertainty faced by individuals investing in human capital, such that risk-averse individuals invest less in human capital where wage inequality is higher as they become less sure of the returns.
Moreover, the economic growth literature features the notion that credit market imperfections imply difficulties for low paid individuals making investments in education and training (e.g. Aghion et al, 1999a). It has recently been argued that the availability, and low cost of, skilled, or white collar, labour is complementary to productivity growth. Caroli and Van Reenen (2001) analyse the determinants and results of organisation changes in UK and French workplaces, finding that a higher ratio of skilled to unskilled pay (within workplaces) is negatively associated with organisational change, which, in turn, has a positive association with productivity growth. Their interpretation is that “cheap skills are beneficial to the introduction of organizational change” (p.1474), but they might equally have concluded that relatively expensive unskilled labour is beneficial. Other papers studying the relationship between workplace earnings and technology have found that workplaces with higher average earnings appear to adopt more new technology (Doms et al, 1997, Chennells and Van Reenen, 1997).
The literature on managerial slack or X-inefficiency (Liebenstein, 1966) also suggests a mechanism by which wage compression may promote productivity.1 The basic idea is that wage distributions alter the external pressures that managers are under. The importance of managerial slack in determining productivity has been highlighted in the literature on product market competition (Nickell, 1996, Boone, 2001, Ahn, 2002).
Aghion et al (1999a, b) incorporate the concept of managerial slack into endogenous growth models, creating a link between more competition and growth. In a similar way the extent of wage inequality is another factor that may constrain managers. The facility of managers to pay (relatively) low wages may reduce the pressure to introduce new technology or work practices, which would be introduced were such low pay precluded (i.e. slowing or even preventing the diffusion of ‘best practice’ techniques or equipment). This argument appears most relevant to wage dispersion in the lower part of the distribution.
Relatedly, from outside the economics community and discourse, much research suggests that greater wage inequality may undermine production performance (see Streeck, 1992; Rogers and Vernon, 2002). Greater wage inequality may not only allow management a simpler route to profitability than that of nurturing productivity growth, but lead to the isolation of management.
This may bring an ignorance amongst management of their workforce and its activities, and a dispiritment of lower paid employees which inhibits their commitment. A nexus of managerial complacency and workforce resignation in combination with limited employee selfassurance and a mis-direction of employee effort may result, possibly allied to illness, with detrimental implications for productivity growth. Yet wage inequality may also be of relevance to aggregate productivity in a more straightforward sense. In the 1940s Gosta Rehn and Rudolf Meidner argued that wage solidarity – equal pay for equal work regardless of the characteristics of the firm – could raise productivity. Their basic argument was that high wages in low productivity firms (sectors) could force them to close, transferring resources to high productivity firms (sectors).
Agell and Lommerud (1993) formalised this ‘structural change’ intuition within an endogenous growth model. The model has two sectors, a modern sector that drives growth via learning-by-doing and a traditional sector. They show that reducing wage dispersion may boost growth as it can increase the resources allocated to the modern sector. Implicit in the model is the idea that the learning-bydoing represents an externality not internalised by profit-seeking firms. Moene and Wallerstein (1997) provide another theoretical discussion of the role of wage dispersion by modelling its impact on firms’ profitability, the entry of new firms and capital stock. Their model assumes exogenous technical change and suggests that wage compression can raise profitability, increase the rate of new firm entry and lead to a more modern capital stock.
In summary, there are a number of mechanisms by which wage dispersion may influence productivity growth. Despite this, to our knowledge, there are no existing empirical studies of the relation between aggregate measures of wage dispersion and productivity growth.3 There is, however, substantial comparative historical evidence that economic growth and income equality are positively correlated, and indeed particularly strongly amongst advanced industrialised countries (e.g. Persson and Tabellini, 1994, Benabou, 1996, Aghion et al, 1999a). Forbes (2000), however, has recently argued, on the basis of particular data and analysis, that whilst it may be the case that greater equality promotes growth in the long term, shifts towards greater equality impede growth.
These growth studies have a different purpose to the present paper, seeking to deal not only with the implications of income as opposed to wage inequality, but with the experiences of not only manufacturing (in which the measurement of output is very much simpler) but private and public services (mostly beyond the OECD), and often disregarding not only working hours but employment rates and demography. Moreover, in contrast to the current paper, these contributions employ summary measures of inequality, not exploring, as here, whether the inequality of the top and bottom half of the distribution may have distinct consequences.
Influences on wage dispersion
Evidently, wage inequality does not fall from the sky. This acknowledgement should not be taken as an indication of the inappropriateness of a focus on wage inequality, as it can hardly be argued that any variable is entirely autonomous from the larger political economy. Yet if it were the case that wage inequality were more or less exclusively determined by a single well-defined influence it might be quite reasonably argued that the focus of attention should be this influence. A consideration of the basis of comparative historical developments in wage inequality is thus of relevance here. A human capital perspective would stress the implications of societal arrangements for schooling, training and human capital formation for wage inequality, whilst leaving aside the political economic basis of these arrangements.
Estevez-Abe et al (2001) present some diagrammatic indication of an inverse cross-national comparative relationship between the extent of nations’ provision of vocational educational and training (VET) and the extent of wage inequality. More specifically, it has been suggested by Nickell and Layard (1999) that inequality across educational opportunities may drive much wage inequality. Yet the detailed work of Devroye and Freeman (2000) on the results of the international adult literacy survey (IALS), demonstrates that the cross-national variation in the inequality in scores can account only for a very small proportion of the cross-national variation in the inequality in wages. It is, rather, returns to ‘skill’ (literacy), and variation in wage at a given ‘skill’ (literacy) level, which are of most importance to comparative wage inequality. The presumption that wage inequality simply, or even principally, expresses educational or human capital inequality is thus contradicted by the available evidence. Alternatively, it might be thought that wage inequality merely expresses physical technology. The skill biased technical change (SBTC) suggests that there is a technical basis to developments in wage inequality left unaccounted for by developments in human capital (e.g. Bound and Johnson, 1992, Katz and Murphy, 1992, Katz and Autor, 1999, Brown and Campbell, 2002). Indeed, this literature might be imagined even to invalidate the current study through its general demonstration of the determination of not only wage inequality, but perhaps also productivity, by technical change.
The literature thus warrants a detailed examination here. SBTC refers to the general idea that increasing demand for the skilled has shifted the availability, terms and conditions of work further in their favour over the last 20-30 years. In a prominent recent paper, Bresnahan et al (2002, p.340) conceive SBTC as ‘technical progress’ which shifts demand in favour of the skilled, whilst noting that it ‘tends to be something of a residual concept, whose operational meaning is “labour demand shifts with invisible causes”.’ Attempts to operationalise it as a causal factor in empirical work have involved the use of various proxies for technical change. Bresnahan et al’s (2002) conceptualisation of SBTC as encompassing change in each of ‘IT use’, ‘organization practices’ and indeed ‘products and services’ seeks explicitly to greatly extend its meaning beyond some notion of physical technology or machine embodied technical change, blurring a critical issue. Caroli and Van Reenen (2001) seek to distinguish ‘skill biased organisational change’ from SBTC, implicitly seeking to delimit and thus retain the latter’s meaning. In empirical practice, as Bresnahan et al (2002) note, the focus has often been on information technology (IT) as a source of SBTC. More specifically, the focus has been on the presence of computing equipment, as in Krueger (1993), Autor et al (1998) and Haskel and Heden (1999). There has also, however, been some work around the commitment to investment in R&D, treating R&D intensity as an indicator of embodied technical change (e.g. Berman et al, 1994, Machin, 1996, Machin and Van Reenen, 1998). It seems clear that if SBTC is to have meaning as an explanatory concept it must refer to the inherent or intrinsic characteristics of physical technologies, or machine embodied technical change, to something outside the black box of the employment relationship; else it is a residual category so vague that it must ‘explain’ everything and will obscure rather than enlighten. Critically in the current context, it should be underlined that the SBTC literature does not seek to establish any relationship between the skill bias of machine embodied 10 technical change it posits and productivity growth. The view that there is such a relationship, even at firm or industry level within the borders of the US, let alone cross-nationally, is thus unsubstantiated. The comparative historical pattern of productivity growth which is the focus here cannot reasonably be regarded as an expression of SBTC. Much else is left unestablished by the SBTC literature, despite the claims made in and for it. The SBTC literature is littered with suggestions that the relationship between technical change, or the implementation of new technology, and developments in wage inequality over the last 20 or 30 years is well established. As a prominent recent example, Bresnahan et al (2002) suggest that Autor et al (1998) provide a corroborative review of the evidence of this relationship. Yet whilst Autor et al (1998) do indeed claim to be addressing not only the relationship between upskilling and the implementation of new technologies (specifically, computer intensity), but also the distinct issue of the relationship between this implementation and wage differentials, their empirical focus is on accounting for shifts in the non-production, or college educated, employee share of the total wage bill. It is not clear how these data relate to wage inequality, even if this is conceived as educational wage differentials. Moreover, their discussion relates solely to the US. The very limited published work on SBTC that does actually seek to account for wage inequality uses inter-industry or inter-firm data, particularly for the US (e.g. Brown and Campbell, 2002).
Yet, even here the evidence is hardly overwhelming. Card and Di Nardo (2002, 776) conclude their detailed survey of the US experience by noting that ‘the evidence linking rising wage inequality to SBTC is surprisingly weak’. Moreover, such a national focus is quite uninformative about cross-national comparative developments. It is quite conceivable that whilst technical change may be of relevance for developments in wage inequality within a particular nation, it may have little or no relevance to comparative developments, being swamped, or rendered impotent, by other influences.
A claim for the importance of SBTC must rest on evidence of a cross-national association between developments in physical technology and wage inequality. The seminal comparative study of the SBTC literature is Machin and Van Reenen (1998).7 This focuses on the shift to non-production from production work in manufacturing, and on the shift in the share of wage costs accounted for by nonproduction employees, rather than on wage inequality per se. The absence of a comparative relation between recent trends in wage bill shares and those in wage inequality is apparent, though implicit, even in the passing reference to developments in non-production-production wage differentials in Machin and Van Reenen (1998). It is still clearer from a comparison of Machin and Van Reenen’s (1998, Figure I) summary of change in non-production wage bill shares over 1973-89, with the development of 90/10 wage inequality detailed by Rueda and Pontusson (2000, Figs 1 and 2) from OECD data. The figures on 90/10 show wage inequality in the US exploding over this period, with that in the UK growing a little,, whilst those on the non-production wage bill share show substantially more growth in the UK than the US. Unfortunately, the figures on 90/10 available on the other three nations featuring in Machin and Van Reenen (1998) do not extend across 1973-89, but there is certainly no indication of a general relationship from that data available on these other nations. Machin and Van Reenan (1998) thus focus on phenomena which bear no apparent relation to wage inequality.