Daniel Freeman is an independent policy analyst. He is the former Managing Editor at the Institute of Economic Affairs.
Last week, the Equality and Human Rights Commission (EHRC), a quango funded by the government to lobby itself, called for mandatory pay transparency. Amongst other measures, the EHRC’s proposals would require businesses to provide employees with information on what their colleagues earn. This came the same day that Chancellor John Healey announced in his Budget speech his support for pay transparency.
Advocates argue that giving employees the right to know their colleagues salary will help them to negotiate their pay more effectively, thereby creating a more efficient labour market and shrinking the gender pay gap. They might acknowledge an additional administrative burden on business, but this has rarely been a clinching argument when it comes to the current government’s labour market policy.
However, what is often underappreciated is the substantial evidence that pay transparency legislation also comes with a significant cost to employees. As Zoe Cullen’s excellent paper summarising the existing research shows, the most consistent effect it has is to drive down wages.
Of the eight major studies of pay transparency laws, six of them found that they led to drops in average earnings. The other two studies, both on the effect of mandatory gender pay gap reporting in Austria, found no change to wages in either direction, but noted an increase in the gender pay gap after the law was introduced.
If you think about it, less privacy on pay leading to lower wages should not come as a huge surprise. When pay privacy is the norm, higher performers are more able to negotiate up their own pay independently of their colleagues. In a transparent environment, employers can argue, not unreasonably, that a pay boost for one worker would lead to an unaffordable increase in the wage bill if everyone in the firm would know and could demand the same.
Social embarrassment can also play a role in putting workers off making higher pay demands if they think that it will be broadcast around the office. The result is a flattening of wages within seniority bands. Those at the higher lose out most, but those in the middle and bottom don’t do much better.
This brings us on to the second major finding of the research on pay transparency; it tends to weaken the link between higher performance and better pay.
Research conducted on American academics between 1997 and 2017 found that greater pay transparency made the link between positive outcomes – measured in terms of articles and books published, as well as patents and grants secured – and higher pay about 40 per cent weaker than it had been before.
Some have argued that this is actually a benefit of pay transparency, because paying high performers more is itself discriminatory. Regardless of what you make of this claim, the UK already has a highly progressive tax system that reduces the take home pay of higher earners and one of the world’s highest minimum wages. This has created serious issues with wage compression, and it is unlikely further reducing the link between labour market performance and living standards will be good news for productivity.
The result of mandatory pay transparency measures would likely be an economy that increasingly resembles the civil service, with rigid pay bands, little financial incentive for higher performance and extremely limited productivity growth.
It should be acknowledged that there are certain forms of pay transparency that can have positive effects, and which employers might want to consider. Vertical pay transparency, i.e. providing workers with information about what their managers are likely to be paid rather than that of colleagues on the same level, can, in some circumstances, boost productivity.
A study of bank employees in Southeast Asia found that providing more accurate information about managers’ pay resulted in a slight increase in the number of hours staff worked, emails sent (an admittedly highly dubious measure of productivity) and sales revenue generated.
This seems to have been because employees underestimated their managers’ pay by 14 per cent and so accurate information made the prospect of promotion seem more lucrative and therefore more worth striving for. However, this effect might well be reversed in a context in which workers find managers are earning less than they had expected.
It’s also worth noting that in Norway, when the income tax records of every citizen were made available online, the reported happiness and self-esteem of well-off Norwegians increased but left low earners more demoralised and unhappy.
So why has the Chancellor in what he billed as “a Budget for the working people of Britain” endorsed a policy that, if international experience is anything to go by, will leave British workers poorer and possibly more miserable as well?
I think part of the explanation is that over the last decade we have seen the culture war grow in importance and supersede traditional economic concerns in the politics of the workplace.
Politicians and campaigners find themselves advocating policies that act against their stated economic objectives because essentially an aesthetic judgement over whether a particular aspect of working culture is more ‘woke’ or ‘based’. Pay transparency is perceived as ‘woke’ so most of the left falls in behind it even though it reduces wages, just as much of the right reacts against home working though there is evidence that it boosts fertility and profitability.
There is nothing wrong with having preferences for how we’d like a workplace to look and operate. But we should resist the temptation to universalise our preferences with the coercive power of the state.
The purpose of this article is not to suggest that pay transparency is always and everywhere bad or should be banned. Some people will prefer to work in firms where pay is revealed and be willing to trade off some of the opportunities for higher performance related pay for greater information and the security that brings. Others may prefer pay privacy and the likelihood of a higher wage.
But the government should leave workers and businesses free to negotiate what works best for them.
Daniel Freeman is an independent policy analyst. He is the former Managing Editor at the Institute of Economic Affairs.
Last week, the Equality and Human Rights Commission (EHRC), a quango funded by the government to lobby itself, called for mandatory pay transparency. Amongst other measures, the EHRC’s proposals would require businesses to provide employees with information on what their colleagues earn. This came the same day that Chancellor John Healey announced in his Budget speech his support for pay transparency.
Advocates argue that giving employees the right to know their colleagues salary will help them to negotiate their pay more effectively, thereby creating a more efficient labour market and shrinking the gender pay gap. They might acknowledge an additional administrative burden on business, but this has rarely been a clinching argument when it comes to the current government’s labour market policy.
However, what is often underappreciated is the substantial evidence that pay transparency legislation also comes with a significant cost to employees. As Zoe Cullen’s excellent paper summarising the existing research shows, the most consistent effect it has is to drive down wages.
Of the eight major studies of pay transparency laws, six of them found that they led to drops in average earnings. The other two studies, both on the effect of mandatory gender pay gap reporting in Austria, found no change to wages in either direction, but noted an increase in the gender pay gap after the law was introduced.
If you think about it, less privacy on pay leading to lower wages should not come as a huge surprise. When pay privacy is the norm, higher performers are more able to negotiate up their own pay independently of their colleagues. In a transparent environment, employers can argue, not unreasonably, that a pay boost for one worker would lead to an unaffordable increase in the wage bill if everyone in the firm would know and could demand the same.
Social embarrassment can also play a role in putting workers off making higher pay demands if they think that it will be broadcast around the office. The result is a flattening of wages within seniority bands. Those at the higher lose out most, but those in the middle and bottom don’t do much better.
This brings us on to the second major finding of the research on pay transparency; it tends to weaken the link between higher performance and better pay.
Research conducted on American academics between 1997 and 2017 found that greater pay transparency made the link between positive outcomes – measured in terms of articles and books published, as well as patents and grants secured – and higher pay about 40 per cent weaker than it had been before.
Some have argued that this is actually a benefit of pay transparency, because paying high performers more is itself discriminatory. Regardless of what you make of this claim, the UK already has a highly progressive tax system that reduces the take home pay of higher earners and one of the world’s highest minimum wages. This has created serious issues with wage compression, and it is unlikely further reducing the link between labour market performance and living standards will be good news for productivity.
The result of mandatory pay transparency measures would likely be an economy that increasingly resembles the civil service, with rigid pay bands, little financial incentive for higher performance and extremely limited productivity growth.
It should be acknowledged that there are certain forms of pay transparency that can have positive effects, and which employers might want to consider. Vertical pay transparency, i.e. providing workers with information about what their managers are likely to be paid rather than that of colleagues on the same level, can, in some circumstances, boost productivity.
A study of bank employees in Southeast Asia found that providing more accurate information about managers’ pay resulted in a slight increase in the number of hours staff worked, emails sent (an admittedly highly dubious measure of productivity) and sales revenue generated.
This seems to have been because employees underestimated their managers’ pay by 14 per cent and so accurate information made the prospect of promotion seem more lucrative and therefore more worth striving for. However, this effect might well be reversed in a context in which workers find managers are earning less than they had expected.
It’s also worth noting that in Norway, when the income tax records of every citizen were made available online, the reported happiness and self-esteem of well-off Norwegians increased but left low earners more demoralised and unhappy.
So why has the Chancellor in what he billed as “a Budget for the working people of Britain” endorsed a policy that, if international experience is anything to go by, will leave British workers poorer and possibly more miserable as well?
I think part of the explanation is that over the last decade we have seen the culture war grow in importance and supersede traditional economic concerns in the politics of the workplace.
Politicians and campaigners find themselves advocating policies that act against their stated economic objectives because essentially an aesthetic judgement over whether a particular aspect of working culture is more ‘woke’ or ‘based’. Pay transparency is perceived as ‘woke’ so most of the left falls in behind it even though it reduces wages, just as much of the right reacts against home working though there is evidence that it boosts fertility and profitability.
There is nothing wrong with having preferences for how we’d like a workplace to look and operate. But we should resist the temptation to universalise our preferences with the coercive power of the state.
The purpose of this article is not to suggest that pay transparency is always and everywhere bad or should be banned. Some people will prefer to work in firms where pay is revealed and be willing to trade off some of the opportunities for higher performance related pay for greater information and the security that brings. Others may prefer pay privacy and the likelihood of a higher wage.
But the government should leave workers and businesses free to negotiate what works best for them.