Wage compression

Wage compression refers to the empirical regularity that wages for low-skilled workers and wages for high-skilled workers tend toward one another. As a result, the prevailing wage for a low-skilled worker exceeds the market-clearing wage, resulting in unemployment for low-skilled workers. Meanwhile, the prevailing wage for high-skilled workers is below the market-clearing wage, creating a short supply of high-skilled workers (and thus no unemployment of high-skilled workers).

Akerlof and Yellen (1990) propose a model that uses the fair-wage hypothesis to explain wage compression. The fair-wage hypothesis suggests that the effort put forth by a worker is proportional to the fairness of her wage, as compared to other workers within the firm. Accordingly, if executives of a given firm are compensated much more highly than the firm’s unskilled workers, the unskilled workers will exert a lower level of effort. In equilibrium, high-skilled wages tend downward, while low-skilled wages tend upward, which defines wage compression.[1]

Moene and Wallerstein (2006) argue that intentional wage compression led to a shift in favour of higher-productivity industries in Scandinavia, as it made low productivity industries less profitable and high productivity industries more profitable.[2]

References
  1. Akerlof, George A; Yellen, Janet L (1990). "The fair wage-effort hypothesis and unemployment". The Quarterly Journal of Economics. 105 (2): 255–283.
  2. Moene, Karl Ove; Wallerstein, Michael (2006). "The Scandinavian model and economic development" (PDF). Development Outreach. 8 (1): 18–21. Retrieved 2020-08-13.
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