Setting Wages: The Importance of Pay Leadership

Wages in ”pay leaders” are a highly influential factor in determining wages in other firms. That is the conclusion of Jennifer Smith of the Bank of England and the University of Warwick in a paper in a recent issue of the Economic Journal. In an article analysing wages in the UK chemical industry during the 1980s, she finds that such wage comparisons, in this case made with wages at ICI, have a far more important effect on wage levels elsewhere than any industry average wages that might provide a fall-back option if pay bargaining were to break down.

Smith notes that there is a substantial amount of evidence, both anecdotal and empirical, that wages elsewhere have an important impact on wage determination. But there is less agreement about why. Is it, as industrial relations specialists emphasize, because workers compare their own wages with those of workers in other firms, using considerations of ”fairness” and ”equity”? Or, as economists tend to believe, because workers think of wages in other firms as their fall-back or outside option in the pay bargaining process? Smith acknowledges the difficulty of empirically disentangling ”comparison” and ”fall-back” wages to resolve whether fairness or bargaining motivations are more important to workers and their union representatives. But ICI”s dominant pay leadership in the UK chemicals industry over the period 1978-89 allows a clear distinction to be made between comparison wages (the wage paid by the leading firm, which is unlikely to represent a fall-back option for all workers) and measures of workers” fall-back (various average industry and regional wages).

Pay leaders act as a focus for wage comparisons, providing a reference wage. But they are unlikely to provide a potential fall-back option: whereas in the event of a breakdown in pay negotiations, workers might be able to find work at wages related to average wages in the industry or region, it is unlikely that they could expect to obtain jobs at ICI, or jobs paying an equivalently high wage. ICI”s wage might form part of the fall-back, but only part; other firms” wages should also matter in determining the level of the fall-back wage. Smith”s econometric evidence suggests that ICI”s wage levels had a greater influence on wage setting in the UK chemicals industry than any of the ”fall-back” wage measures. This confirms the existence of pay leadership and suggests comparisons made by workers can explain a good part of the influence of wages elsewhere in wage determination. Wage interactions do not simply reflect the fact that wages in other firms constitute workers” fallback option in the bargaining process.

”Wage Interactions: Comparisions or Fall-back Options?” by Jennifer
Smith is published in the March 1996 issue of the Economic Journal

Dr Jennifer Smith

associate professor | Department of Economics at the University of Warwick | 024 7652 3469 | jennifer.smith@warwick.ac.uk