Ryan Johnson's WorldatWork blog has a great post about variable compensation and economic inequality. In it, he calls our attention to a recent Business Week column where author James Sherk of The Heritage Foundation posits that pay for performance programs have been a significant contributor to the growing economic gap (between our richest and poorest citizens) and that there is an upside to economic inequality that is being overlooked in current discussions of this trend.
In Sherk's column:
According to a study by the National Bureau of Economic Research, much of the increased inequality in the past generation - including almost all the gains among top earners - occurred because companies upped their use of performance pay. That is, inequality has risen for a good reason: The economy is increasingly rewarding hard work.
Of itself, inequality is niether positive or negative. What mattes is why incomes are unequal. In a class-based society where a few families control wealth through inheritance or coercive means, rising inequality does indeed cause harm. Higher inequality, in 17th century England or in Saudi Arabia today, means increased hardship for most workers.
However, in a society where most wealth is earned, some great inequality can benefit most citizens. Consider Google Inc. founders Larry Page and Sergey Brin, each worth $16 billion, thanks to their stake in the search giant. Their success has amde America a demonstrably less equal country - who wouldn't want to swap paychecks with them? - yet most people are better off for it. Google's services allow tens of millions of Americans to find what they want fast on the Internet and use a quality e-mail service free of charge. Page and Brin got rich, and thus increased inequality, by improving the lives of others.
The growth in popularity of pay for performance, particularly variable or incentive pay, is undeniable. As Ryan points out, WorldatWork's very own research confirms the steady climb in the number of organizations who report using variable pay, up to 79% in the most recent Salary Budget Survey. Taking this point further, the NBER study notes that "the growing incidence of performance pay can explain 24% of the growth of male wages between the late 1970's and the early 1990's, and accounts for nearly all of the top end growth in wage dispersion."
Certainly we can all point out cases of wealthy individuals who did not get to that place on the basis of good performance (not only a number of CEOS but also some professional athletes come to mind), but I think that Sherk makes a worthy point that - as Ryan notes - may not be getting due consideration in today's public policy debates.
Sherk's closing thoughts:
Yes, an economy that rewards hard work generates inequality. But that economy is indisputably fair. That's why, rather than bemoaning inequality, policymakers must search for ways to expand the number of jobs that can base pay on performance and allow more workers to share in the gain.
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