Project: Wage Differentials and Heterogenous Jobs.

Subject: Labor Economics

Class: BS Economics 6th
Submitted by: Tuba Jabbar
Submitted to: Amtul Hafiz
Date: May 30, 2021
Contents
INTRODUCTION:..........................................................................................................................2
Compensating differentials..........................................................................................................2
Sources of wage differentials.......................................................................................................3
Differences Based on Efficiency Wage.......................................................................................3
Shirking Model and Wage Differentials......................................................................................4
Turnover Model and Wage Differentials.....................................................................................4
LITERATURE REVIEW................................................................................................................4
Pilar Romaguera (1991)...............................................................................................................4
Terhi Maczulskij (2013)..............................................................................................................5
Paul Sullivan (2013)....................................................................................................................5
Robert A. Hart (2013)..................................................................................................................6
Paul Sullivan (2020)....................................................................................................................6
Analysis...........................................................................................................................................6
Conclusion.......................................................................................................................................9
References......................................................................................................................................10

Wage Differentials and Heterogenous Jobs

INTRODUCTION:
Why does a teacher earn lesser than a pilot? Why does a doctor’s annual income increase by
many folds than that of a painter? Heterogeneous jobs have differing non-wage attributes like
supply and demand of labor. It not only requires different skills but also Involves different
efficiency wages to increase the productivity.
We have observed that the individual pay dispersion accounts for more than two-thirds of the
total, even after adjusting for employees' peculiarities (e.g. educational level or professional
experience) and job-specific variables (e.g. occupation and industry). Salary differences between
workers with similar productive capacities remain largely unexplained and cannot be fully
accounted for by empirical models, despite the fact that cross-worker productivity differences are
generally considered the main source of wage heterogeneity in economic literature (Becker,
2009). (Hornstein et al. 2011).
The causes of wage differential among employees have been debated since the beginning of
economic research. Human capital (HC) theory is perhaps the most developed of the several
wage differential theories in terms of the quantity and quality of contributions. Its core message
on wage differential is that people profit economically because of a collection of distinctive
attributes like education, experience, or ability: the higher the productive capacity, the bigger the
advantage. Due to which, various salaries are paid to various people based on their productive
capacity. As a result, disparities in productivity across employees' human capital dictate pay
disparity totally. Other individual factors that may change the projected return given a set
productivity level are taken into account in certain expansions of the theory.
The labor market segmentation theory which is another theory formed to explain the wage
differentials is a close derivation of discrimination and compensating differential theories. This
theory, which is sometimes stated to compete with HC theory, views the labor market as being
divided into several segments, each with its own set of wage regulations and employment laws.
Wage differences between comparable employees occur in segments of the labor market where
HC returns are lower than the rest of the market (Lang and Dickens, 1992).

Compensating differentials
Compensating differentials refers to the extra income given to a worker in exchange for a
negative job attribute that does not exist in alternative jobs. Also known as a salary premium or a
pay equalizer. The pay disparity is due to a decrease in the supply of workers for jobs with
unfavorable job characteristics and an increase in the supply of workers for alternative jobs. No-
wage features of work vary widely and are a source of wage differential compensation. These
compensating differentials are equilibrium wage differentials in that and they do not lead
employees to shift to higher-paying employment, causing wages to equalize.
Sources of wage differentials
• Risk of job injury/death: When there is a high danger of getting hurt or killed on the
job, the labor supply for that occupation will be lower than for jobs with safe working
conditions. Compensation for salary differentials will be paid in employment with a
higher risk of accidents than other occupations.
• Fringe Benefits: Employers who recruit comparable people and pay comparable salary
rates have a wide range of fringe perks. For example, sick leave, paid vacations, and
medical insurance, to name a few. Firms that do not offer fringe benefits will be required
to pay compensatory salary differentials in order to recruit skilled personnel. The gross
hourly compensatory pay differentials between two businesses will be equalized as a
result of this.
• Job status: Some occupations, such as those in the electronics sector, provide significant
status and reputation and attract a huge number of people. Other jobs, such as working in
a sewage treatment facility, have a lower rank and reputation. To recruit workers, this
industry must provide compensatory salary differentials. As a result, job status has an
impact on labor supply, and compensating compensation differentials may arise as a
result.
• Job location: Similar jobs have a wide range of employment locations, which affects the
cost of living. Cities like Islamabad, which are known for their livability, may attract a
big number of employees. Cities with an industrial smoke problem are less appealing to
employees. Faisalabad, for example. As a result, pay differentials may need to be
compensated.
• Job security: Various occupations give long-term job security and guarantee that one
will work a full week every week throughout the year. Other jobs, such as construction
and consulting, have a lot of ups and downs in terms of employment and pay. Because a
consistent wage check is not guaranteed every week of the year. These jobs appeal to a
small number of individuals. Workers in these jobs may be eligible for compensatory
salary differentials. The hourly income may be rather high in order to compensate for the
low likelihood of working 40 hours per week for the full year.
• Prospects of job advancement: In addition, jobs vary in terms of how much a company
invests in human capital over the course of a year. For example, a 22-year-old banking
employee can expect on-the-job training and the possibility of advancement to a higher-
paying position over time. A carpenter's earnings are unlikely to rise much over time.

Differences Based on Efficiency Wage

Employers may find it lucrative to pay salaries above market-clearing levels in particular
circumstances. Efficiency wages may help explain compensation differentials among individuals
with equivalent credentials since these factors change within and between sectors. Wage
disparity arising from efficiency wage payments will be equilibrium differentials since
enterprises will have no incentive to cut their salaries, even if eligible employees agree to work
for less money.

Shirking Model and Wage Differentials

According to the shirking model, employers would pay efficiency wages where it is expensive to
monitor employee performance or if the employer's cost of bad performance is significant. The
employer's cost per effective unit of labor is reduced because the above-market compensation
increases the cost of job loss to workers. This encourages conscientious efforts and lowers the
employer's cost per effective unit of labor.
However, monitoring employees is affordable or the cost of individual worker misconduct is
minimal, on the other hand, the cost per effective unit of labor will be minimized at the lower
market-clearing pay. These disparities in conditions will result in pay disparities that are
unrelated to skill differences or nonwage perks.

Turnover Model and Wage Differentials

When hiring and training expenses are high, the turnover version of the efficiency wage model
suggests that companies pay above-market-clearing salaries. The higher-than-market
compensation raises the job's value to the employee, lowering turnover (quit rate).As a result,
both the average degree of employment experience and the firm's labor productivity increase.
The idea is that salaries might vary between and within sectors based on the efficiency benefits,
if any, resulting from pay techniques that aim to raise the job's worth from the worker's
perspective.
Assume that everyone prefers the same amount of time to make money. They chose the job with
the best chance of making more money at a given pay. Jobs with fixed lifetime pay will have a
lower labor supply. Pay differentials at the entry level will be necessary to compensate for this.
As a result, a doctor's starting salary may be less than that of a teacher. Wage growth, on the
other hand, will be faster.
LITERATURE REVIEW
Pilar Romaguera (1991)
Normative or sociological models that anticipate a pattern of strong correlations across all
vocations inside a company produce the most consistent outcomes. This hypothesis is supported
by evidence of rent-sharing procedures even when union strength is minimal. Rent-sharing
arguments might also be used in conjunction with other EWMs. In this sense, our results confirm
the conclusions that have been obtained for the US economy: firms tend to pay higher wages to
some occupations, owing to turnover, effort elicitation, recruitment or other reasons, but at the
same time they also face equity constraints that lead them to pay high wages to all the other
occupations.
One of the main predictions of the EWMs is that wages will tend to be sticky. Therefore, if
efficiency wage considerations are applicable to the Chilean economy—as this investigation has
attempted to prove—a pattern of sticky wages in the Chilean economy should also be predicted.
The behavior of wages in modern firms during the 1975-1986 period support such hypothesis.
Finally, with respect to LDCs’ wage structures, contrary to what was assumed by other
researchers, we found a higher dispersion of inter-industrial wages in Chile compared with the
US manufacturing sector. Nor is there a pattern of decrease of these differentials with higher
levels of development. We interpret several of our results as a reflection of a more heterogeneous
industrial structure in LDCs than in developed countries.

Terhi Maczulskij (2013)

This study adds to the growing body of knowledge about why persons with various family-of-
origin characteristics choose to work in government. Furthermore, it is critical to investigate how
these characteristics influence wage differentials between public and private sector workers, as
this knowledge would be useful for political science in general.
The wage differential analysis provides a number of informative findings. In particular, the OLS
results indicate a negative wage differential for both males (seven per cent) and females (four per
cent), thought we do not find any clear inequalities with respect to pay offered by the two sectors
when unobserved ability, other variables related to genetics and differences in experiences
related to family background and family resources are differenced out from the analysis.
We can thus conclude that neglecting the control of genetics and shared environment effects in
estimating the impact of public sector work on 160 employees’ earnings will yield downward-
biased estimates. Interestingly, it seems that the bias with regard to the wage gap for males is
entirely caused by genetic factors.
This finding could reflect the fact that the private sector attracts relatively more able male
employees than the public sector (e.g., Nickell and Quintini, 2005; Pfeifer, 2011); that males
who have higher risk preferences tend to select private sector employment over public sector
employment (e.g., Hartog et al., 2002); or that males who have better economically rewarded
attributes (such as attractiveness and social skills) tend to self-select into a private sector
occupation. This selectivity pattern could make it challenging for the public sector to retain high-
quality male labor.

Paul Sullivan (2013)

Equally capable employees must get the same total compensation in a frictionless and
competitive labor market, and the projected salary difference for a job attribute must match the
workers' willingness-to-pay for that feature. Unfortunately, there is little evidence to back up the
hypothesis (Brown, 1980). In labor markets with frictions, on the other hand, total job values or
"jobs" are dispersed, and total utility will in general exceed a worker's reservation utility,
resulting in different compensation packages for different, equally capable workers, biasing
estimates of compensating wage differentials.

Robert A. Hart (2013)

The recent era of economic history reviewed here helps to remind us that throughout times of
great economic crises, piecework performed two key functions. First, piecework provided a
degree of short-run hourly procyclical pay adjustment, in contrast to the prevalent Keynesian
assumption of downward real hourly wage rigidity.
At the margin, this would have helped to preserve engineering jobs during the Great Depression.
Such adjustment was especially noticeable in the modern manufacturing firms of the southern
and midland districts of Britain, such as aircraft and vehicle manufacture. Second, a piece rate
system that rewarded productive effort was best suited to meet the intense and urgent pressures
of demand in war supply industries during the build up to, and execution of, a major military
conflict.

Paul Sullivan (2020)

By estimating an on-the-job search model that allows employees to search across jobs based on
both salaries and job-specific non-wage utility flows, the relationships between job dispersion
and the typically limited evidence for compensating pay differentials were investigated in this
research. Voluntary job-to-job shifts, compensation adjustments at transitions, and work
durations all illustrate the relevance of non-wage value.
A highly uniform sample and control for unobserved worker heterogeneity were chosen because
not accounting for worker ability is a common rationale for the frequent failure of compensating
wage disparity estimates. Using a simulated data set based on the model and parameter estimates,
it has been observed that job dispersion leads to severely biased compensating wage differential
estimates.
Job dispersion is exacerbated by differences in worker ability and in an on-the-job search
framework, by job dynamics (“utility ladder”) and controlling for these sources of job dispersion
ameliorates the bias. Nevertheless, MWP estimates still have a downward bias of nearly 40
percent. Indeed, estimating total utility on worker type and the reservation utility reveals that 33
percent of job dispersion must be due the inherent dispersion in job offers.

Analysis
Wage dispersion is one of the most important predictions of Efficiency Wage Models, as
previously stated. However, neither the competitive model nor the majority of Efficiency Wage
Models can explain why companies using various technologies coexist in the same sector. In this
respect, Efficiency Wage Models can only explain the presence of inter-industry pay disparities,
not intra-industry wage disparities. As a result, to induce interindustry dispersion, some external
assumption is required.
To obtain heterogeneity across businesses, one option proposed in the literature is to suppose that
one source of production has a flexible supply to the industry but a constant supply to the
business. Furthermore, we may assume that there are empirical issues that result in intra-industry
heterogeneity, i.e., we will see some product difference even if we are very diligent in our
empirical research of the industry.
Wage premium and company characteristics are also predicted by efficiency wage models, albeit
the relation between the two sets of variables differs depending on the model. In this way,
Efficiency Pay Models formalize prior claims concerning the impact of industry factors on wage
dispersion reported in the literature. Consider Lester's and Stigler's monitoring and screening
hypotheses, respectively. The relationships between Efficiency Wage Models and company
features, as well as the predictions of Efficiency Wage Models in terms of firm wage behavior,
The nutritional model predicts that the efficiency wage for employees in surplus supply will
remain constant, that various pay arrangements will exist for employees on long- and short-term
contracts, and that stable long-term employment arrangements would predominate (Rodgers,
1975 and Bliss, and Stern, 1978).
A recruitment model (Lang, 1988) is an exception, in which a vector of capital and salary
combinations is in equilibrium. 8 Oi (1983) shows that, under the premise that entrepreneurial
talent is a specific scarce input, an industry would contain heterogeneous enterprises of various
sizes and production structures. Higher salaries are predicted under the shirking model in
companies with high monitoring expenses and/or a high cost of employee misbehavior.
Similarly, in organizations where turnover is more costly, the turnover model predicts higher
pay. Various hypotheses then connect these efficiency wage costs to observable business
features.
Large companies are thought to have greater shirking/monitoring expenses. Because bigger
companies' production processes are more intertwined, every breakdown, delay, or industrial
accident will be more expensive. Furthermore, greater wages save monitoring entrepreneurial
time, which has a bigger opportunity cost in bigger corporations.
Furthermore, shirking may be linked to capital endowment, in the sense that it will be costly for
businesses that utilize pricey capital equipment (in the extreme shirking could be associated with
smashing the machines or stealing inputs or products). The size of the company has also been
linked to turnover expenses.

If companies share at least some of these expenses, they will be more motivated to limit
turnover. Large companies also have greater screening expenses. Weiss and Landau (1984)
propose a screening model in which the productivity of a firm's top workers and the quantity of
applications are determined by salaries. They show that salaries and business size are positively
associated in this situation. As result that is driven by the fact that large firms need more
workers.
Large enterprises have a greater cost of getting worker information under Garen's (1985) model.
Because of the disparities in screening processes between large and small businesses, there is a
positive correlation between company size and salaries. The author's estimates seem to support
both hypotheses. A link between capital, profits, and salaries is predicted by the recruitment
models.
Workers are concerned with their wage and opportunity cost in most Efficiency Wage Models,
which are assessed by an average wage and the unemployment rate. Workers are also worried
about their relative pay inside the business and their previous earnings, according to the
sociological model, since these relative salaries impact their view of being treated properly.
Large, capital-intensive companies, in particular, should choose for a system that mitigates the
effects of shirking or allows for easier monitoring. However, based on the aforementioned
reasoning, we conclude that efficiency wage models imply that large enterprises with substantial
capital investments and profitability should anticipate higher pay. Furthermore, the sociological
model predicts that enterprises would pay all jobs high or low wages.
For two different sets of employers and workers, this graph depicts the best combination of wage
rate and job safety. The employees have similar human capital pools, but differ in their
preferences for the nonwage job amenity of safety. Given the condition of competition in
respective industries, the iso-profit curves depict the greatest profit levels feasible for the
enterprises. The slopes of the curves show how much it costs each business to improve worker
safety.

Conclusion
Wage dispersion is one of the most important predictions of Efficiency Wage Models, as
previously stated. In this respect, Efficiency Wage Models can only explain the presence of inter-
industry pay disparities, not intra-industry wage disparities. Wage premium and company
characteristics are also predicted by efficiency wage models, albeit the relation between the two
sets of variables differs depending on the model. In this way, Efficiency Pay Models formalize
prior claims concerning the impact of industry factors on wage dispersion reported in the
literature.
The relationships between Efficiency Wage Models and company features, as well as the
predictions of Efficiency Wage Models in terms of firm wage behavior, Workers are concerned
with their wage and opportunity cost in most Efficiency Wage Models, which are assessed by an
average wage and the unemployment rate.
References
Kyyrä, T. (2007). Retrieved from
https://helda.helsinki.fi/bitstream/handle/10138/21792/studieso.pdf?sequence=1
Maczulskij, T. (2013, june 6). Retrieved from
https://jyx.jyu.fi/bitstream/handle/123456789/41560/1/978-951-39-5215-
0_vaitos06062013.pdf
Romaguera, P. (1991). Retrieved from
https://kellogg.nd.edu/sites/default/files/old_files/documents/153_0.pdf
Sullivan, P. (2013, september). Retrieved from https://www.bls.gov/osmr/research-
papers/2013/pdf/ec130100.pdf