The Problem of Wage Compression

The decision by the city of Chattanooga, Tennessee, to stick with a 3% across the board pay increase for city employees as opposed to a $1.00/hour one was a sensible one.  But it brings up an issue common in labour relations, namely that of wage compression.

A quick summary of the facts: the Mayor had proposed the 3% increase.  But the trade union (the SEIU) had campaigned for the $1.00/hour increase, and it looked for a time that the City Council would go along with it.  But in the end the percentage increase prevailed.

The problem with what we used to call "cents an hour" increases (now $1) for everyone is that, over time, it produces wage compression.  As an example, consider a pay scale with the lowest wage $7/hour and the highest $14/hour.  The highest wage in this case is double the lowest.  If we apply a percentage increase each year (or whenever increases are applied,) the highest wave will remain double the lowest, and the increases all have the same relationship with whatever inflation rate is going at the time.

Now let’s consider three successive $1/hour increases.  The bottom wage is now $10/hour and the top $17/hour.   But now the top wage is only 1.7 times the lowest rather than 2 times the lowest.  Over time, with this type of increase, two things happen.

The first is that the lowest wage (unskilled or entry level) people end up above the market rate.  This not only discourages hiring people at this level, but it also encourages the company or government entity to contract out work at wage and benefit levels which are usually way below what the company or government entity would have paid if they had stuck with percentage increases.  So people eligible for work such as this end up being hurt.

The second result is that people at the highest job classifications end up underpaid, with wages either below market level, not keeping up with inflation, or both.  Those who can will seek work elsewhere, which over time will dilute the calibre of the work force.

Inequities in pay scales can and should be dealt with.  The City of Chattanooga has a study currently under way to try to remedy problems like this.  But trade unions traditionally hate to adjust pay scales because it creates division in the bargaining unit.  A flat rate increase is an easy way out for a union.  But in the long run the interests of both employer and employees are hurt by the practice.

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