When Does It Make Sense to Pay Workers Higher Wages?

Wage growth since the start of the COVID-19 pandemic has been strange, to say the least.

Wages grew at historic rates over 2020 – between 2019 and 2020, wages grew by 6.9% for the typical worker, according to the Economic Policy Institute – but that figure may be a little misleading. Most of the jobs lost in 2020 were held by wage earners in the bottom 25% of wage distribution, so the average wage naturally went up because remaining workers were already higher earners: “The exit of 7.9 million low-wage workers from the workforce, coupled with the addition of 1.5 million jobs in the top half of the wage distribution, skewed average wages upward.”

Then, the first quarter of 2021 saw the best quarterly wage growth since at least 2001, according to Business Insider, which reports that wages and salaries grew by 3% for private industry workers. Average hourly earnings have continued to increase through June.

Is this wage growth sensible, and will it be enduring? Even more fundamentally, when does it truly make sense to rapidly increase pay, perhaps even more than industry average?

First, it makes sense to raise wages when increased pay is required to get workers in the door.

The current restaurant sector is a good illustration of this point. Restaurants nationwide have had to delay reopening, reduce capacity or hours, or otherwise curtail service simply because they can’t find enough staff. A recent survey from the National Restaurant Association (NRA) found that 72% of restaurant operators see recruitment and retention as their top challenge, which is the highest rate in 20 years. In another recent survey, the NRA found that 82% of operators had job openings that were “difficult to fill.”

The solution? “We have to pay more,” Amanda Cohen, the owner and chef of the award-winning restaurant Dirt Candy in New York City, told The Guardian.

Second, it’s sensible to raise wages when increased pay will lead to better performance and output.

The Pareto Principle (which states 20% of the inputs produce 80% of the outputs) is often cited here, meaning that on average 20% of workers will produce 80% of the results. But another principle may apply too: Price’s Law, which states that half of the work is done by the square root of the number of people who participate in the work. In other words, the top 5 performers on a team of 25 will generate half of all sales, according to this idea.

Does that theory hold up in the real world? Laszlo Bock, former SVP of Google’s People Operations, would probably argue so. In his book Work Rules! he says that “the top 1% of workers generated 10 times the average output, and the top 5% more than four times the average.”

A study by the Workplace Research Foundation has similarly found that taking steps to increase employee engagement, like increasing wages, can lead to $2,400 more profit per employee per year. Higher wages can motivate workers to perform better. It also means they have more to lose if they underperform and are demoted or terminated. Plus, higher wages reduce the incentive to leave the company to seek better compensation elsewhere, particularly for top performers whose productivity can truly justify more pay.

CoAdvantage, one of the nation’s largest Professional Employer Organizations (PEOs), helps small to mid-sized companies with HR administration, benefits, payroll, and compliance. To learn more about CoAdvantage’s ability to create a strategic HR function in your business that drives business growth potential, contact us today.