The Mystery of the Vanishing Pay Raise

Businesses push incentives for managers to limit pay raises, and it works, because the economy is softer than it seems and people can’t quit to get higher pay elsewhere.

The labor market is a lot softer than a 5.1 percent jobless rate would indicate. For one thing, the percentage of Americans who are working has fallen considerably since the recession began. This disappearance of several million workers — as labor force dropouts they are not factored into the jobless rate — has meant continued labor market weakness, which goes far to explain why wage increases remain so elusive. End of story, many economists say.

But work force experts assert that economists ignore many other factors that help explain America’s stubborn wage stagnation. Outsourcing, offshoring and imports exert a steady downward tug on wages. Labor unions have lost considerable muscle. Many employers have embraced pay-for-performance policies that often mean nice bonuses for the few instead of across-the-board raises for the many.

Peter Cappelli, a professor at the Wharton School of Business, noted, for instance, that many retailers give managers bonuses based on whether they keep their labor budgets below a designated ceiling. “They’re punished to the extent they go over those budgets,” Professor Cappelli said. “If you’re a local manager and you’re thinking, ‘Should we bump up wages,’ it could really hit your bonus. Companies have done this in order to increase the incentive to hang tough on budgets, and it works.”

In recent years, wage increases, before factoring in inflation, have averaged about 2 percent annually. But real, after-inflation wages have remained dismayingly flat since 2009, according to the Bureau of Labor Statistics, even though real wages did bump up last fall when the drop in oil prices pulled down inflation.

But high performers are getting raises:

Another important trend depressing pay is that more than ever, companies are paying top dollar to star performers — whether marketing wizards or software programmers — while skimping on paying the many workers without special skills.

“Right now the labor market is good if you’re a new graduate of Harvard or Stanford in computer science or a new economics Ph.D. or if you’re coming out with a specialized skill in some health occupation,” Professor Katz said. “The upper 10 percent are probably doing O.K. in the labor market, but typical workers are still facing a lot of difficulties.”

As part of this embrace of pay for performance, many companies are giving raises or one-time bonuses only to their best performers, thus helping retain and attract top talent while subtly showing the door to less stellar workers.

“The higher performers are attracted to and will stay with organizations that differentiate higher performers,” said Ken Abosch, North American compensation practice leader for Aon Hewitt, a consulting firm. “Low performers are uncomfortable working in environments that emphasize higher performance so they will sort themselves out.”

In a study of 1,200 American companies, Aon Hewitt found that 25 percent overwhelmingly emphasize rewards to high performers and give far less or nothing in raises or bonuses to average or poor performers. “Those 25 percent say, ‘We’re going to give 6 percent to the top performers, 1.5 percent to average performers and we’re not going to give anything to below average,’ ” Mr. Abosch said.

Just 10 percent of companies give equal raises spread across the board, Mr. Abosch said. And the remaining companies do something in between — giving somewhat higher raises to top performers and somewhat less to everybody else.

This last development is a trend I am watching, which I call Next Inequity, one element of the complex of factors, trends, and technologies I call Next Work. More to follow.

The Mystery of the Vanishing Pay Raise

Written by

Founder, Work Futures. Editor, GigaOm. My obsession is the ecology of work, and the anthropology of the future.

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