Faculty Opinion

The combination of tight labor markets and low wage inflation is perhaps the most important puzzle presented by the contemporary economy. To understand it requires rethinking our traditional perceptions of employment and the wage setting process.

To begin with, tight labor markets no longer imply job security, as evidenced by a Conference Board survey last year in which 63 percent of employers said they no longer offered long-term job security for loyalty. In another 1997 survey, this one by the American Management Association, 49 percent of the companies interviewed reported that they eliminated jobs during last year, despite an economic expansion. For virtually all of these companies, the causes were internal — restructuring their operations and competencies — and were not associated with any current decline in business. In addition, more than 30 percent of these companies were hiring new employees at the same time that they were eliminating jobs elsewhere, resulting in a “churning” of their skill base.

New management techniques that essentially bring the market inside the firm reinforce the sense that employees are in competition to keep their jobs. Benchmarking, for example, conveys information to employees about how their wages and costs stack up against those in other organizations even as employers point out that certain functions are candidates for outsourcing. Workers clearly seem to have gotten the message. Ninety-four percent of employees in a 1997 Towers Perrin survey report that they see themselves and not their employer as responsible for their job security. Employees understand that pushing up labor costs is not the way to do it.

While employees do seem to be switching employers more frequently now, the employment relationship has not become one of free agency. Except in a relatively few fields where jobs are almost perfectly portable, such as computer programming, employees are not yet hopping from job to job in search of higher pay. What we see instead is what I term “serial monogamy” — open-ended relationships that both sides understand can be terminated at any time. Employers these days frequently rely on contingent compensation — based on productivity gains — to bind key employees to them; for executives the compensation is paid out of shareholder value. Neither approach puts as much pressure on labor costs. Employees who see jobs as more temporary than in the past are also less likely to move simply for a raise in salary given that the raise, as well as the job, may not last long.

Employees today are changing occupations less frequently. At the same time they increasingly see themselves as having a functional orientation in which they define themselves by their particular skill, not their company affiliation. A person is a marketing manager rather than a Xerox manager.

In the past, companies had compensation structures that maintained pay differentials between areas and jobs by raising wages across all jobs when the market went up in one area. Companies are less interested in doing that now and, in general, are less interested in having common compensation structures across jobs and functional areas. This is partly because managerial employees in particular are not moving across functions and occupations. In some companies, market-driven increases do not even spill over to other jobs in the same field. Special “hot skills” premiums in fields like computer programming raise wages, temporarily, only for jobs based on those skills. If the company changes operating systems or for other reasons no longer needs that skill, the premium goes away as well.

Meanwhile, new accounting techniques such as profit-and-loss responsibilities at operating levels punish employers for raising wages. Wage increases for new hires are especially resisted because of the danger that they could lead to demands for increases among current employees. Instead, many companies are investing in recruiting, seeking out non-traditional applicants such as welfare recipients or retirees and doing a better job of screening. In some cases, employers support these new hires with social services and other arrangements to increase the retention rate. In other cases, relatively modest investments in training allow employers to lower their standards for applicants yet get the new employees quickly up to speed. While arrangements like these increase labor costs, they do not bid up wages in the market and may well be less expensive than raising wages to get better applicants.

High Marks for TQM & Teamwork

A final component of the tight labor market puzzle is the fact that skill requirements continue to rise. Fifty-one percent of the employers in the 1997 National Employer Survey conducted here at Penn report that the skills needed to perform typical front-line jobs adequately have gone up in the past three years; only two percent thought they had declined. If the demands are rising, shouldn’t the shortage of workers be even worse and the pressure on wages greater?

This is not the case because most workers already have the skills needed to meet these rising demands. The demands are mainly associated with new work systems like TQM and teamwork that push more responsibility and decision-making onto employees. Virtually every study indicates that employees like these new systems. One of my studies indicates that employees are even more satisfied with the level of their pay when these systems are present. Another study found that where employers pay more, it is not because they are hiring in more qualified applicants. The higher pay seems to be a premium to encourage greater effort and attention on the part of the employees.

A new, more market-based relationship exists between employer and employee, and employers have found ways to manage it in the face of tight labor markets without raising wages, much to the benefit of many areas of society. Inflation does not seem to be an immediate problem, but one that might be is the fact that employers who have not been able to meet their hiring needs are simply letting vacancies stand empty rather than raise wages to fill them.

But there is a risk to not filling vacancies: During expansionary times, employers could find themselves without the manpower to take advantage of the upswing. The best way to minimize that risk is by investing now in efforts to seek out qualified applicants and find ways to retain them. For years, the big problem in most companies was how to get rid of unwanted employees. Now the problem has shifted to finding and then keeping those employees whose skills are scarce. The key to competitiveness may lie in solving that problem.

Peter Cappelli is professor of management, chairman of the management department and director of the Center for Human Resources.

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