Where Inequality Matters

People do care about their income relative to others, especially coworkers:

A randomly chosen subset of employees of the University of California was informed about a new website listing the pay of all University employees. … The vast majority of new users access[ed] data on the pay of colleagues in their own department. … Workers with salaries below the median for their pay unit and occupation report lower pay and job satisfaction, while those earning above the median report no higher satisfaction. Likewise, below-median earners report a significant increase in the likelihood of looking for a new job, while above-median earners are unaffected. (more)

If, as seems likely, coworker envy is much stronger than envy of distant strangers, then it is good to let each firm choose its internal level of inequality.  They internalize most of the envy externality, and so have good incentives to trade that against other relevant considerations in choosing employee incomes.

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  • Providing, that is, that inequality is published. Clearly, employees will use information about their relative pay to reevaluate their satisfaction with their job. Firms benefit from informational inequality, because they will be more likely to keep underpaid workers. Efficiency would be increased if disclosures of the type mentioned above were mandatory.

  • Interesting that those with higher pay didn’t report higher satisfaction. I wonder how that stands with the forced comparison hypothesis which I would have thought would have suggested that they would be happier.

    Besides that…

    The other way, of course, for companies to deal with the costs associated with employee inequality would be to try to prevent employees from knowing what their co-workers earned. I was contractually prevented from discussing my income with fellow workers at a bank I once worked at. I didn’t much care for the job so flouted the contract whenever I could.

    I only very occasionally managed to enter into conversation on the subject. Most co-workers didn’t want to get into trouble. One lady, who had worked at the bank as a teller for near to twenty years revealed to me that she received five dollars more a week than I did. I asked her if she was upset that her loyalty was barely rewarded. She said she wasn’t upset in the least!

  • RJB

    …it is good to let each firm choose its internal level of inequality. They internalize most of the envy externality…

    I don’t understand what these statements mean.

    What is the alternative to “letting” firms choose their internal rate of inequality? Are you opposed to forced revelation of salaries? Demanding it? Are you arguing against limits to CEO salaries, or other policies that would mandate how firms pay workers? There are so many bigger problems with having outsiders choose the salaries of a firms’ workers, envy seems like a minor factor to consider.

    What does it mean for a firm to internalize the envy externality? That the firm will alter its pay levels to avoid causing workers too much unhappiness? Or pay money to prevent inequality from becoming too visible?

    Maybe the time change has hindered my reading comprehension.

  • Robert Frank had an NYT piece on inequality within firms a little while ago. You and some others had a number of interesting responses.

    A commenter at Marginal Revolution linked to a paper on behavioral economic studies of inequality aversion, but I just skimmed through it as it was mostly over my head.

    • Jeff Ely has a post on inequality aversion, with a proposed experiment.

  • Pangolin

    I am quite sure that the satisfaction stems from a perception of being paid less for equivalent work. There is also just an inherent component in human psychology that makes us notice and care about injustices that affect us negatively, but nothing that makes us happy when we are on the higher end of injustice. Everyone involved probably just considers those at the higher range to be making the proper amount for the job.

  • Doc Merlin

    I think of it very differently. It shows them what ‘market wages’ are in their field and allows them to more accurately assess if they should shop around for a better paying position, or ask for a raise.

  • nazgulnarsil

    of course no one would ever consider that they are a below average worker.

  • I like the current system somewhat, where government for the most part has very public and standardized pay grades, while private industry is all over the map, but generally with lots of variation and hiding. The level of irrationality about pay and self-worth is so high that there is no reason to believe that freer flow of information would lead to a more efficient system. In my case, I love bonuses and no raises. I will barely remember I made $10,000 more last year because of a super bonus that was not repeated, but a $2000 pay cut will fry my eggs.

    UC is a government controlled school. You will not find that kind of openness or standardization at a private university (unless it is being run by someone driven by theory over experience.)