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Inside the Firm Review: Part III

Remuneration and Compensation

In light of the worldwide slowdown in economic growth and productivity in most advanced industrialized countries in the 1980s and 1990s, real wage growth was held back and income inequality grew. In such a milieu, a wide variety of forms of payment emerged in the industrial landscape. In some countries, there was a growth in contingent pay, which means compensation that is contingent on some measure of performance which can be assessed at the level of the individual, workgroup, plant or firm. Examples are profit sharing, employee stock ownership plans and bonuses. In most countries, there was also a modest trend toward compensation based on skills or competencies attained rather than for specific tasks performed or on the basis of seniority. Many firms also moved their employees from wages and salaries as part of the process of reducing status differentials between blue-collar workers and salaried staff.

Japan has conventionally been seen as having highly developed seniority wage systems, but these apply to only a relatively small proportion of the workforce located in large enterprises. This has changed in recent times with the wide introduction of ability-based or performance- based wage systems. For most employees, much of their annual income is related to the profit performance of their employing organization. In Australia, despite a tradition of centralized wage determination, there has been a movement toward enterprise-based bargaining which is designed to take greater account of the economic performance of the firm in wage negotiations. There has also been a trend toward employment contracts with complex compensation packages negotiated for a fixed period of years. In theory, the renewal of such contracts depends on a number of factors, including the achievement of agreed performance targets.

While this approach was initially confined mainly to professional and managerial staff, it is increasingly applied to the unionized workforce. Rather paradoxically, contingent forms of compensation were found to be more extensive in Japan, Australia and Europe than in USA and Canada. Firm conclusions are not possible but the plausible hypothesis is that employers and unions outside North America demonstrated greater willingness to negotiate over issues of wage flexibility and apply a wider diversity of methods of compensation in return for wage increases. By contrast, North American employers have focused more narrowly on simply reducing the level of real wages. Watson Wyatt Worldwide, which makes money by advising employers how they could make money by adopting suitable compensation policies in a world of “constant change and unforgiving competition”, has come to the conclusion that “no single type of reward plan guarantees success—i.e. there are no silver bullets” although its annual surveys of Strategic Rewards practices in America do indicate that “organizations that have an overall strategic approach to rewarding employees perform better overall”.

It is very critical of the merit pay for performance in that it “is the primary vehicle for employee retention. However, it has lost almost all the power it may have once had to motivate performance or reward an employee for attaining skills or competencies important to the organization….As the workforce ages and tenure lengthens over the next decade, companies are likely to place even less emphasis on merit pay increases. Why? Having achieved entitlement status, merit pay largely rises with age and tenure. That link could cause payrolls to rise dramatically. Only de-linking pay from age and tenure and re-linking it to performance and productivity, such as through Strategic Rewards plans, can protect a company from the cost impact of an ageing workforce.”

In the context of organizational innovations for productivity and quality in the auto industry, in theory, the use of piece rates to get more productivity does not hold good because it contradicts with the made-to-order JIT production and quality botheration of the employers. But piece rates as a compensation-related device is commonly found in most of the subcontractors attached to the lead firms of the auto industry. Piece rates induce higher productivity and higher pay for the workers. But the worker focuses on quantity over quality apart, there is the problem of lack of incentive to avoid wastage of materials which is important in lean production.

Furthermore, piece rates reward individual behaviour, not teamwork, and might encourage competition where cooperation is required. If employers institute teamwork, then they will have to install group piece-rate systems. But this invokes the aforementioned 1/N problem if the group becomes too large. In case employers offer promotions as rewards to get the best behaviour from executives and non-supervisory employees, that will not work because, as with individual piece rates, competition for a few higher opportunities above rather than cooperation is encouraged. “Office politics and sabotage are part of popular corporate lore as a result”.

Most employers, especially in larger firms, pay on a time basis (per hour, per week, per month, or per year). But higher productivity does not materialize without considerable monitoring. Employers may set a minimum work standard and dismiss those employees who do not measure up to it. They may institute merit pay in terms of merit bonuses or wage increases based on subjective supervisory evaluations like in the Japanese factories. The “pay for performance” wave which came into vogue in the 1980s is not a new idea. The idea of having an element of pay based on the performance of the firm, plant, workgroup, or individual—also known as pay or wage flexibility is an old one.

However, some employers prefer to avoid pay-for-performance altogether! Many employers in the US showed “employer militancy” during the 1980s, by doing aggressive wage-cutting despite theories like 'efficiency wages' or the historical example of Henry Ford using the theory of efficiency wages for the first time successfully, guiding them not to do so. This apart, the topic of 'performance appraisal' with all its new fads coming from the USA—like the 3600 feedback in terms of self-appraisal, peer appraisal, subordinate appraisal and appraisal by customers, internal and external--is so confusing, murky and dysfunctional-prone that it is not really a developmental tool to objectively get the best out of the employees; it is more likely to become a subjective exercise in negative sanctions to promote the American culture of “hire-and-fire-at-will”. Some scholars have highlighted five principles that underscore the international convergence towards an optimal flexible payment system to boost productivity: “(a) Flexible pay should not be a substitute for guaranteed pay. Roughly speaking, 70 per cent of the pay can be fixed and 30 per cent variable. Normal pay revisions may reflect changes in the cost of living or per capita incomes in the country; (b) Pay revision should lag behind productivity improvement.

Define the lag period; (c) Performance appraisal system should be revamped to define and measure performance; (d) Define profits, the share of workers, and procedure for sharing; and (e) Provide a measure of stability in workers' income by pooling workers' share in excess of 30 per cent of their pay into a fund that can be used to pay to workers in lean years for imparting a sense of stability in their earnings”. Let us consider the issue of bonus which ranks next only to wages in its adverse impact on industrial peace and harmony in India. At the outset,a bonus is a simple apple-pie statement to understand as an incentive to promote the productivity of the workforce and so it should be integral to any productivity-boosting restructuring such as lean production. But in the Indian context,a bonus is really a bastardized concept; the government through its legislation and the judicial system interpreting that legislation, have both mucked it up as a perennial cumbersome bone of contention without clarity and precision.

If the bonus is treated as 'deferred wage', the implication is that the employees would be entitled to 13 months' wages for 12 months' work and it is perfectly logical. In this version of thinking about bonus, it is totally severed from profits and becomes a 'statutory liability' of compulsory character. In such an event, there can be no question of paying more than 8.33 per cent under any circumstances. If, on the other hand, bonus is regarded as 'profit-sharing' and/or 'productivity-linked', it is certainly a welcome measure, in the context of industrial restructuring based on lean production, for the employers as also employees, because both parties can formulate their strategies to improve productivity and/or profits and of sharing the gains thereof. Such an arrangement is supposed to infuse a sense of competitiveness in both the employer and the employee as the focus automatically shifts from 'fixed-pie' to 'expanded-pie' bargaining. Operational efficiency becomes the focal point and payment of bonus thus becomes a rational 'contingent liability'. If this argument is accepted, then the idea of a bonus as a 'deferred wage' should be dropped.

The matter is made extremely confounding by the argument that bonus should be treated as both, which does not make any sense. The problem of lack of clarity and the absence of corrective justice, distributive justice and productivity-boosting justice permeates not just the bonus issue, but the whole ambit of the procedures and practices of industrial dispute resolution covering gratuity, wage structure and unfair termination of service of workmen as well. Such is the world of industrial relations system in India even as judicial activism, even from the High Courts and the Supreme Court has been by and large in tandem with the employer militancy in the neoliberal times. There is no logically and practically sound incentive system that is compatible with JIT-TQM production which can be universally applied to get the best results. Moreover, the question of incentives—fixed and variable—is not a mathematical question but a “social question which workers and management should decide among themselves keeping in mind their common interests and conflicting interests….The mechanism of collective bargaining tries to do just that by asking labour and management to negotiate with each other.

In spite of all its imperfections, this is probably the best method we have right now. Other methods of wage determination are even more unsatisfactory.” Why do employers impose compulsory overtime on workers under lean production, much to the dislike of many workers? “Employers find it cheaper to increase the hours of their regular employees. Compulsory overtime, even though it might have to be paid at a premium wage rate…., is cheaper than hiring new workers, who have to be trained and for whom there are hiring costs and fringe benefits. Fringe benefits payments do not increase if a regular worker works overtime, but they do rise if a new worker is employed. The use of overtime work then makes it difficult for new workers to find fulltime employment, and these workers form a pool of exploitable part-time workers.” Interestingly, it is not that workers are not willing to take on overtime. In fact, the increased demand for overtime work by employers is heightened by the increased willingness of workers to do it. What explains this behaviour?

“Workers who experience increases in family income quickly raise their expenditures for all sorts of consumer goods and services. They increase their use of credit and get caught in …a cycle of 'getting and spending'. To pay their bills and maintain their increased consumption, they work as much overtime as they can get…In addition to their employer's demand for forced overtime and the get-and-spend cycle, many of these workers had also experienced extremely insecure employment as plants in the industry shut down in the 1980s and 1990s. They were 'willing' to work long hours today in part because they might be victims of another plant shutdown tomorrow. During breaks, some of them would tell me that they had been working twelve hours a day seven days a week….The plight of people doing long hours of involuntary part-time work in the rich countries pales in comparison to the working lives faced by the third world proletariat (including the components of this proletariat sweating it out in the rich countries). For these workers, labour is a matter of life and death, all day, every day.”

” In discussing compensation, wages should be distinguished from compensation. Compensation includes not just the hourly or weekly or monthly wage but also additional costs such as fringe benefits. The most important benefits are health care and pensions. In much of the world these are very low or nonexistent, and so in effect wages and compensation are about the same. But in rich countries, benefits are often significant. One can thus understand how employers in rich countries turn away from compensation to only low wages by finding ways of exploiting the workers, especially the nonstandard workers, in the emerging economies such as India and China. Although instituting 'productivity linked wages' is considered as a way of making the wage structure flexible and the right way of motivating the workers under lean production, can we really measure individual worker productivity and explain the wages he receives in relation to it? No. The answer is as follows: “According to the (neoclassical) theory, inequality in income is simply the monetary reflection of inequality in productivity. This notion can be challenged on both theoretical and empirical grounds.

Although capital in the form of machinery, buildings, and equipment is productive in the sense that, other things equal, the more capital per worker, the more output is produced, the ownership of capital is not a productive act. Therefore, income from the ownership of the nonhuman means of production cannot be justified on the grounds that the means of production are productive. A significant fraction of the nonhuman means of production become the private property of individuals through inheritance, and these cases the argument that the inheritors are productive is particularly ridiculous….It is ownership that generates income, not productivity. The neoclassical explanation of wage inequality is likewise suspect. If we say that wages reflect productivity, we must be able to measure the productivity of individual workers. This, however, is for the most part impossible….In industrial settings, work is not an individual process; it involves the necessary cooperation of large groups of workers. The productivity of an individual worker is a meaningless concept….The neoclassical theory predicts that equally productive workers will make equal wages.

This is manifestly not the case. If we look at workers across the world and observe the astronomical differences in wages among workers, this prediction looks increasingly preposterous. The Mexican workers making car engines for General Motors or Ford are as productive as their Detroit counterparts, but the pay of the former is a small fraction of that of the latter.” So, as the lead automobile firms internationalise themselves and adopt JIT-TQM production in developing country context, workers are as productive or even more productive than workers in the developed countries even as they get paid a pittance. If this is not low-road super-exploitation, then what is? How can the protagonists of lean production sell the idea of the high road in terms of high wages under lean production in developing countries? The sheer ideology of myths.

The “fact that neoclassical economics is so wrong yet so powerful tells us that it is not a science but an ideology.” Lastly, what explains executive pay, i.e. the colossal compensation for the CEOs of the corporations? Nothing. “…only one simple conclusion is possible: Pay is not correlated in any way with the value these leaders create for shareholders, society or any other corporate constituency. CEOs largely pay themselves…Recent protests—Occupy Wall Street, of course, but also the Tea Party movement as it first began—rise out of a profound rage over unfairness in this country (US).

The scale of this unfairness and inequity makes it hard to know where to direct that rage, to know what to do. Occupy Wall Street has the right target; but where their rage will go, nobody today knows… any alert board should be instructing their managers to do three things: admit the problem exists, take positive steps to make the corporation function fairly, and consider what other steps would address the concerns of the protests”. What should shareholders do in this context? “They must promptly and credibly associate themselves with the protesters complaining against corporate unfairness—and then present themselves as legitimate vehicles for addressing the problem. The autocratic power of CEOs is fundamentally at odds with the sustainable functioning of corporations in a democratic society. Institutional shareholders must move quickly and decisively. They should defend and legitimate their right to own property and to be responsible for corporate conduct”. A sensible view indeed. Click here to read Part IV.

By Annavajhula J.C. Bose,
PhD Department of Economics, SRCC

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