Labor Economics Skill Based Pay Systems

Question: Discuss about the Labor Economics Skill Based Pay Systems. Answer: Introduction The organizations operating at the large scale are concerned about managing the labor problems. This involves management of pay and performance of the employees. The pay and performance are correlated to each in the positive manner. This implies that when the employees get higher pay, it is generally assumed that their performance will also be higher. On the other hand, when the employees get pay less than the average market rates, it is normally observed that their performance also goes down (Hill Jones, 2009). Further, there are other adverse situations that may arise in the firm paying low wages such as high employee turnover, labor strikes, outrage etc. Further, from the organizational view point, when the firm pays higher wages, it incurs high cost which reduces its profits. However, the increased cost due to high wages may be compensated by increased productivity of the labor. Thus, it is crucial to maintain an adequate balance between the pay and performance to achieve the lo ng term goals of the organization (Hill Jones, 2009). This report is focused on carrying out the discussion in the pay and performance related theories and issues. The discussion in this report extends to efficiency wage theories which aim to assist in striking out proper balance between the pay and performance of the employees. Further, the report also provides practical application of the theories in resolving the pay and performance related issues. The theoretical knowledge is of no use unless it has been applied to make the things work in the practical environment. Therefore, the efficiency wages theories as discussed in this report have been practically applied to resolves the conflicts. Background of the organization Fair Work Commission Australia The Fair Work Commission Australia was established in the year 2009 with the primary aim of providing for administration of the matters related to workers pay. The commission has been set up under the special statue namely Fair Work Act 2009 (Australian government, 2016). The overall functioning of the commission is handled by the president of the commission with the assistance of administrative staff. The act contains all the provisions pertaining to the industrial relations between the workers and the employers. Further, Fair Work Commission also provides services of a tribunal in the matters related to the workplace relations. Apart from that the functions of the commission also include providing for the rules to set minimum wages, setting the fair process of bargaining, providing for conditions to be included in the employment agreement. Moreover, the commission is also involved in dealing with the disputes between the workers and the employers (FCW, 2017). Literature Review The theory of motivation states that positive attitude towards the work could be created among the employees by rewarding and praising them. Further, it states that the output of the workers largely depends upon the effectiveness of pay (Reilly, 2003). The pay and performance are directly related to each other. However, the impact of pay and performance on the firms profits is just opposite of each other. The pay to employees is the cost and thus, it reduces the profits and conversely, performance is output and thus, it increases profits. The crucial thing for a firm is to maintain adequate balance between the two to achieve the goals and objectives of the business. With the aim to explore the key concepts, ideas, and theories related to pay and performance, literature review has been carried as under: General Labour Supply and Backward Bending Labour Supply Curve The labour supply theory establishes the concept of labour hours that a worker would wish to work for a given level of wage rate (Dunlop Segrave, 2016). The concept is depicted graphically by plotting the wages rate on vertical axis and hours on the horizontal axis. There is a direct relationship between the wages rate and working hours. It has been observed that with the increase in the wages rates the number of hours also increases. However, this relationship can exist up to certain limit only because there are limitations on the working capacity of a worker. There comes a third factor, apart from the wages rate and working hours, namely labour leisure. Definitely a worker could earn more by working more hours, but then there has to be a cut in the leisure time (Dunlop Segrave, 2016). Thus, there must be a balance between working hours, leisure time, and wages rate to achieve the optimal performance output. The labour supply curve given below depicts these relationships: Figure 1: Backward Bending Labor Supply Curve (Smith, 2003) From the chart presented above, it could be observed that the labor supply curve is bending backwards. There are two crucial things in the formation of labor supply curve such as substitution effect and income effect. The substitution effect precedes the income effect (Smith, 2003). As per the principle of substitution effect, when the workers get increment in the wages, it allures them to work more. Therefore, with the increase in the wages, the workers are willing to increase the number of working hours. However, the substitution effect remains up to a certain limit and then it is replaced by the income effect. The arrival of income effect causes the labor supply curve to bend backwards. The income effect arrives when the wage rate has reached to the level where workers needs are satisfied. Since the wages rate has gone higher, now the worker can earn needed money in less time, therefore the number of working hours get decreased. The decrease in number of working hours with the inc rease in wages rate causes the labor supply curve to bend backwards (Smith, 2003). Efficiency Wage Theory: Shirking Model, Turnover Model, and Adverse Selection Model The wages efficiency theory provides crucial concepts that help in brining effectiveness in the performance through optimization of pay of the workers. This theory helps in exploring the ways to increase the output of the workers (Yellen, 2013). According to this theory, the firms can achieve improvement in the output of the workers by paying them at the rate higher than the average market rate. The term efficiency wages means paying the workers according to the individuals efficiency. This implies that there will be differentiation in the workers pay depending upon the efficiency. However, the modern efficiency wages theory states that paying the workers higher than the market clearing rate would benefit the firms not only in the form of increased productivity, but also in various forms. For example, it helps in avoiding the shirking of the workers resulting in reduction in the labor turnover. Further, as the labor turnover is low, thus, it also helps in reducing the labor recruitme nt and training costs (Yellen, 2013). The shirking model further extends the principles of efficiency wages theory by stating that paying worker more than the market equilibrium will help in avoiding employee from shirking (Cahuc, Carcillo, Zylberberg, 2014). The extra pay will induce them to work for the firm for longer time, which would be helpful in improving the productivity and reducing the costs. As per the shirking model, it is crucial for the firms to pay higher than market average to motivate the workers to make full effort. This model assumes that the firms have limited resources to deploy in monitoring the workers. Further, the fact is that the firms can not eliminate shirking even by deploying huge amount of resources. This is because monitoring and controlling can not change the attitude of the workers. In order to change the attitude of the workers, it is important to motivate them through rewarding them and paying them higher wages. It is crucial to note that paying higher wages to the workers would be le ss costly than spending on the monitoring and controlling measures (Cahuc, Carcillo, Zylberberg, 2014). The turnover model also advocates the efficiency wages theory. As per this model, the labor turnover is very costly for the firms. The labor turnover not only affects the productivity but is also causes additional cost to be incurred in hiring and training the workers (Deb, 2009). This model suggests that in order to avoid the costs of labor turnover, the firms have to pay wages higher than the market average. The inducement of higher wages is necessary to retain the employees for longer time period. Though, it is not necessary that the labor turnover would be eliminated in full, but certainly it would be reduced greatly by paying incentive to the workers. Further, the adverse selection model also states that the firms paying higher wages achieve higher productivity. The model prescribes that the firms paying higher wages are able to higher more capable workers. This model assumes that the ability of the workers and their pay directly relates to each other (Deb, 2009). Pay-Performance Structure The pay structure of the firms should such that promotes equality and stability in the long run and enhances workers efficiency. These objectives can be achieved by linking the pay with the performance (De Silva, 2017). The determination of the wages through government regulations need to be restructured by incorporating the performance as the crucial factor. The traditional system of wages determination took factors such as seniority, cost of living, and profits into consideration in deciding the wages of the workers. The linkage of workers performance with the pay was missing. Further, the consideration of long term impact on the profits was also missing in determining the wages rates. The firms used to focus on reducing the costs and improving the current profits. However, cutting costs to improve profits in the short run is dangerous for long term sustainability (De Silva, 2017). It is the established fact that sustaining long term growth in productivity is not possible without increase in the real wages rates. In the year 1980, Singapore changed the wages rate system to increase the wages rates (De Silva, 2017). The increase in wages rates by linking the wages pay to the performance is necessary to enhance productivity of the workers. Practical Application of Efficiency Wage Theory and Pay Performance Structures The essence of efficiency wages theory is that the firms should structure the wages rates by linking them to the performance of the workers. The theory states that the firms have to pay additional wages to retain employees for long time and achieve the long terms sustainability (Li, Liu, Li, 2008). However, implementing the system of pay that is based on performance measurement is not as simple as it might look like. In order to implement concepts of efficiency wages theory, the firm has to be equipped with effective evaluation measures. Further, the performance evaluation system of the firm should work in an unbiased manner. The parameters to evaluate performance of a class of employees should be applicable equally to all the workers in that particular class (Li, Liu, Li, 2008). The firms in Singapore are opting for the performance based wages systems so as to focus on optimizing the output and ensuring long term sustainability (DBS, 2014). The remuneration report of DBS bank discloses that the banks remuneration policy is aimed at attracting, motivating, and retaining employees. The bank seeks to link the pay of workers with their performance. The total compensation of the workers contains both the fixed as well as variable component. The fixed component comprise of salary while the variable component consists of incentives and bonus which are linked with the performance (DBS, 2014). Figure 2: DBS bank Pay Structure (DBS, 2014) The fixed salary offered by the company is competitive and comparable to the market average, which makes it attractive for the workers. Further, the DBS adopts analytical approach in fixing the salary by taking into account the factors such as market dynamics, skills, and experience. The fixed salary is reviewed for increment on an annual basis considering the market conditions. The bank makes every effort to retain the right talent through increments in the salary at the rate higher than the average market rate (DBS, 2014). Further, the variable part of compensation comprises cash bonus and incentives which are linked to the performance of the workers on individual basis as well on group/department basis. The bank maintains adequate system for performance evaluation which is crucial to implement the performance linked compensation policies. For the bonus eligibility, the workers performance is evaluated based on the balanced score card methodology (DBS, 2014). The balance score card helps in linking the performance measurement with the organizations overall goals and objectives (Niven, 2010). Further, the bank also offers awards to the workers on achieving the target output. In addition to this, the bank also provides deferred incentives or rewards in the form of shares to retain the talented employees. The share based incentives accrue over the years because these are given to retain the employees. The benefits of linking the pay of workers to their performance are enormous. The firms can make differentiation points by adopting a superior pay performance structures. The quality and quantity both are affected positively when the workers are kept motivated and interested in their job. DBS has been able to get a competitive edge by retaining skilled and experienced workforce and the primary reason for this retention of the skilled and experienced has been the pay performance structure of the bank (DBS, 2015). However, there are various challenges in implementing the pay performance system within a firm. The meaningful evaluation of the performance is always the biggest challenge. Further, it is not sure that performance of every worker will improve because everyone does not get motivated by money (Li, Liu, Li, 2008). Recommendations and Comments Based on the findings of the report, it could be recommended to the Fair Work Commission Australia to adopt a suitable pay performance structure that promotes equality and motivates the worker to work efficiently (Wilkinson et al., 2009). The commission should set the wages rates keeping a portion fixed and other as variable. The variable portion of the wages pay should be directly linked to the performance of the workers. Further, the firms should implement incentive policies on same lines as implemented by DBS bank. The firms should also have adequate mechanism for making effective evaluation of workers performance. In this regards, it is recommended that the firms should adopt balanced score card strategy as the mechanism for performance evaluation (Wilkinson et al., 2009). Conclusion The discussion carried out in this report revolves around the issue of fixing the pay of workers based on the performance. In this regards, the report provides discussion on the efficiency wages theory and various concepts connected with this theory such as employee shirking and employee turnover. The efficiency theory is based on the belief that the firms paying higher wage only can sustain in the long run. The firms can retain the workers for longer time by paying them higher wages than the market equilibrium rate. The retention of workers is important to reduce labor turnover and enhance the workers efficiency. Further, the reduction in the employee turnover also reduces the recruitment costs such as hiring cost and training cost. Therefore, it is crucial to implement the performance based pay to achieve the long terms goals and objectives of the firm. References Australian government. 2016. Fair work act 2009. Retrieved March 12, 2017, from https://www.legislation.gov.au/Details/C2016C01108 Cahuc, P., Carcillo, S., Zylberberg, A. 2014. Labor Economics. MIT Press. DBS. 2014. Remuneration Report of DBS of 2014. Retrieved March 13, 2017, from https://www.dbs.com/annualreports/2014/pdfs/governance/dbs-2014ar-remuneration.pdf DBS. 2015. DBS Group: How we create value. Retrieved March 13, 2017, from https://www.dbs.com/annualreports/2015/how-we-create-value/index.html De Silva, S. 2017. An introduction to performance and skill-based pay systems. Retrieved March 13, 2017, from https://www.ilo.org/public/english/dialogue/actemp/downloads/publications/srspaysy.pdf Deb.T. 2009. Managing Human Resource and Industrial Relations. Excel Books India. Dunlop, J. Segrave, M. 2016. The Theory of Wage Determination. Springer. FCW. 2017. About us. Retrieved March 12, 2017, from https://www.fwc.gov.au/about-us Hill, C. Jones, G. 2009. Strategic Management Theory: An Integrated Approach. Cengage Learning. Li, Y., Liu, W., Li, H. 2008. The Theory of Pay Effectiveness. International Journal of Business and Management, 3(6), pp. 93-96. Niven, P.R. 2010. Balanced Scorecard Step-by-Step: Maximizing Performance and Maintaining Results. John Wiley and Sons. Reilly, P. 2003. The link between pay and performance. Retrieved March 12, 2017, from https://www.employment-studies.co.uk/system/files/resources/files/mp18.pdf Smith, S.W. 2003. Labour Economics. Psychology Press. Wilkinson, A., Bacon, N., Redman, T., Snell, S. 2009. The SAGE Handbook of Human Resource Management. SAGE. Yellen, J.T. 2013. Efficiency Wage Models of Unemployment. American Economic Association, 74(2), pp. 200-205.