Are wages determined by market forces, or do businesses get to decide what pay they offer to workers? This question gets at the heart of a lot of the debate about the economy. Why has wage growth been so sluggish for so many years?
If you’re on the market-forces side of the wage question, you might answer that productivity growth has been weak. If you’re on the side of the debate that believes corporations have considerable power to pay workers what they want, thwarting market forces, then you might answer that employers have made the decision to boost profits at the expense of raising wages.
Of course, few people—and even fewer economists—believe that one factor or the other has no role at all in the determination of wages. But it is common to hear some prominent analysts and organizations on the left argue that the link between wages and productivity for most workers has effectively been severed for decades. Likewise, many on the right quickly dismiss the importance of non-market factors in explaining wages.
Let’s focus on typical workers and on low-wage workers. For them, the standard story finds businesses competing for employees, driving up wages to the point that workers are paid according to their contributions to the company. Businesses don’t pay employees less than the value of their productivity—the amount of revenue workers generate for their employer—because doing so would result in their workers taking another job where they would get paid what they’re worth. In this sense, employers don’t “decide" what wages they pay. Instead, wages are set in markets.
Not so fast, say many economists and commentators. This story leaves out some important, and recently much-discussed, corporate policies that allow employers to pay workers less than market wages.
Over the summer, more than a dozen major restaurant chains—including McDonald’s, Applebee’s and Jimmy John’s—removed “no-poaching agreements" from their contracts with franchisees. These agreements prohibit workers at one McDonald’s restaurant, say, from getting a job at another McDonald’s franchise. These agreements are surprisingly common among low-wage employers, and they may act to put some downward pressure on wages by thwarting the competitive market mechanism through restricting the options workers have to shop around for a different, higher-paying job.
“Non-compete agreements", in which workers agree not to join or start a rival company for a certain period of time after leaving their current employer, are a similar policy. These agreements make sense in some situations for “knowledge workers" and executives who possess considerable intellectual assets regarding their current employer.
But the evidence suggests that about one-fifth of all workers, including lower-income workers, are covered by a non-compete arrangement as well. This is harder to understand. And again, by restricting workers’ options, these policies may be suppressing wages somewhat.
I applaud the end of no-poaching agreements in restaurant chains and do not see a valid reason for non-competes to apply to lower-wage workers. In general, I’m am all for making labour markets more competitive. But I’m sceptical that these corporate policies are having a major effect on the earnings of typical and low-wage workers.
How often are such agreements enforced? And if a McDonald’s cashier can’t get a job at another McDonald’s down the street, why can’t he just go to Burger King? It’s hard to imagine that these restrictions are significantly lowering his wage. And there is little evidence to show they do.
This is not to say that frictions in the smooth operation of the competitive market mechanism don’t give employers some power over the wages they offer. But the most important frictions are not driven by corporate policies.
Mobility costs, for example, are much more important. It costs time and effort to change jobs, and takes money to move to a different city for a better job. This gives employers some power over wages. For example, a business could keep wages for some workers below their market level if those workers don’t want to incur the costs of changing jobs. Another critical factor is the lack of information workers have about what they could earn elsewhere, which likely reduces mobility.
Despite these important factors, in my view worker productivity remains the dominant force in setting wages. For one, mobility costs and similar factors are much stronger in the near term than over longer periods of time. It may be hard for me to move my family across the country, but it’s relatively easy for a recent college graduate without a spouse and kids or for a newly arrived immigrant to do so. And intuitively, there is a limit to how far an employer can push its wages below the market wage. Over time, that business will find it hard to hire and retain workers, and to get them to put in a hard day’s work. Market forces are powerful.
A recent paper by economists Anna M. Stansbury and Lawrence H. Summers of Harvard confirms this. They find that over the last four decades, a one-percentage-point increase in productivity growth is associated with a 0.73 percentage point increase in the growth rate of median compensation. That’s a strong link.
Such evidence is dispiriting for those of us who want wages to grow faster. It’s much harder for government policy to juice productivity growth than to clamp down on anti-competitive corporate practices.
Michael R. Strain is a Bloomberg Opinion columnist.