There are two competing economic theories for what determines wage levels in the marketplace. The classic model is based on long run lasting effects from the expansion and contraction of the economic cycle which in turn drive wage rates; essentially tying wages to supply and demand for labor over time. The alternative model, which has been gaining support since the 1990s, is that wage levels are driven by what economists call “contemporaneous conditions”. Economists generally agree that the present condition of the economy is the primary factor in determining wage levels. Another way to phrase it is job seekers who are currently employed are motivated by current labor market conditions and not by long run macroeconomics.
An employer’s willingness to increase pay is influenced by the supply and demand of particular skills and the presence of market constraints. When a particular type of skill or knowledge is in demand and the labor supply is tight then the wages will increase. Alternatively if the demand is weak and the labor supply is high, wages will be constrained. A perfect example of this is what has occurred in manufacturing industries since the 1980s. As more and more manufacturing industries down sized or increased productivity through automation, the demand for skilled production line workers diminished as did the wage level.
What is interesting is the relationship of wage rates and the cost of living is disjoint. Cost of living increases tend to be longer term while the increases in labor costs are more dependent on current conditions. Market wage rates and their change are based upon the supply of and demand for labor, which often changes without any consideration of the cost of living. The cost of living is a measure based upon the area’s cost of goods and services as surveyed by the federal government.
The correlation between these two measures has drastically changed over time. In the 1980’s and into the early 1990’s there was a closer correlation between wages and cost-of-living and many organizations would provide cost of living adjustments to wages when employees relocated for their jobs from a lower cost of living area to a higher cost of living area. Today, the wages paid in the local market where the job resides is the primary factor in setting wage levels.
Supply and demand and the prevailing pay or comparable wages are all determined by market forces and factors. Comparable wages are the most widely used factor for determining wage rates. Comparable wages help an organization remain competitive and aid in the goals of attraction and retention. A widely acceptable definition of fair wages by both employers and employees is, ‘the wages paid by other employers for the same type of work’. The wage rates paid in the industry or locality will form a base for setting wage rates. When an organization lags the market competition, workers will leave their jobs for higher pay somewhere else. It will not be possible to retain good workers for long periods.
Essentially, the market wage is the lowest wage an employer can pay to attract and keep the quality of employees he needs. He can pay more than the market wage, but he can’t pay less. If he pays less in a tight market he will have higher turnover and not enough quality workers. For the worker, the market wage is the highest wage offered by any of the employers he’s willing to consider. He can work for less, but it would not make sense to do so for a long period of time unless there are offsetting benefits such as a shorter drive time, free parking or other incentives.
The interplay between all of these factors leads employers to decisions regarding where to set their wage levels and employees to enter into wage agreements with employers. At WageWatch our compensation consultants are focused on your organization’s compensation needs and ready to help you ensure that your compensation programs are supporting your company’s business strategy and objectives. WageWatch also offers accurate, up-to-date benefit surveys, salary surveys and pay practices data that will allow you to stay current with the times. This information is highly beneficial in creating the best salary and benefits packages that meet or rival the industry standards. For more information on our services, including consulting, salary survey data, benefit survey data and market compensation reports, please call WageWatch at 888-330-9243 or contact us online.