Economics 101: When it comes to wages, fairness is not the crucial measure

Laypeople often demand that the side benefiting from an 'unfair' advantage change it in the interests of fairness, while economists shun such terminology.

Do employers worry about fair wages in the GCC and beyond?

One salient difference between economists and non-economists is that the latter are often observed describing prices, including wages, as being “fair” or “unfair”, whereas economists will scarcely use such terms.

In fact, laypeople will often demand that the side that is bene-fitting from an “unfair” price change it in the interests of fairness; for example, demonstrators frequently insist that companies such as Nike pay higher wages to their employees in developing countries.

The reason that economists shun such terminology in the context of labour markets is that according to economic theory, backed by rigorous statistical evidence, the major determinants of wages are the worker’s ability to generate revenue for the company and the competition between workers for the job.

If you want to get a raise, rather than claiming to your HR director that your current remuneration is unjustly low, economists would urge you to either obtain a superior outside offer, which you can use to bargain for a higher wage, or to demonstrate to your organisation that your work is creating higher revenue for it than before, or than it currently perceives.

Like all models, be they in economics, geology or medicine, the traditional labour market model does not apply perfectly to all situations and economists have identified important settings where perceptions of fairness have a significant impact on wages.

Humans exhibit an acute aversion to having their wages decreased, even if it is by a small amount. In contrast, having wages increased by a comparable amount has a much more modest effect on a person’s disposition. Moreover, raising the prices of important commodities while keeping someone’s wage fixed, thereby lowering their effective (real) wage, is deemed much more acceptable to workers than a direct wage cut, even if the two might have an equivalent effect on living standards (this is known as “money illusion”).

As a result, companies take great care to avoid cutting wages. For example, managers may prefer to lay off 10 per cent of employees than keep everyone and cutting wages by 10 per cent, because they fear the demotivating effects of the latter option.

Another area where perception is significant is wage comparisons. Once inside an organisation, workers are averse to large compensation differences within teams because of humans’ built-in tribal mentality.

If a manager is considering replacing an existing worker with an outsider willing to do the same work, but for a lower wage, then the manager will hesitate for two reasons: first, the other team members will be angered by what they perceive to be a mercenary act of disloyalty toward the incumbent; second, once the new arrival acclimatises and realises that others are paid more, he or she may also rebel.

In the GCC, fairness perceptions can have a different effect due to the prevalence of public sector work, where salaries are determined by factors other than a worker’s productivity, including the government’s desire to provide secure jobs to its citizens.

In particular, once an employer overtly acknowledges that factors other than the organisation’s bottom line will play a role in wage determination, workers will vociferously appeal to fairness considerations during wage negotiations, as they seek to exploit the manager’s humanity. Anticipating this, civil service bureaus preemptively devise highly rigid wage structures, effectively tying managers’ hands.

Closing one door, however, merely motivates workers to look for a different one and that is one reason why senior GCC policymakers, who do have the power to override rigid wage structures, might find themselves being petitioned by waves of government employees wanting wage increases. And as Victor Hugo remarked: “Being good is easy, what is difficult is being just.”

Omar Al Ubaydli is the programme director for international and geopolitical studies at the Bahrain Center for Strategic, International and Energy Studies, and an affiliated associate professor of economics at George Mason University in the US.

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