Preston J. Miller - Former Vice President and Monetary Adviser
Published December 1, 1989 | December 1989 issue
It's ironic. The upheaval in Eastern Europe tells us that planned economies don't workthat countries incur tremendous costs when they abandon the incentives and discipline of the market. As the new East German Prime Minister, Hans Modrow, put it, "This damned bureaucratic regulation...has ruined us." (Newsweek 11/20/89, p. 31). Yet, here in the United States, a major effort is under way to abandon the market in favor of bureaucratic decision-making.
The effort goes by the name of comparable worth. Its proponents argue that it is needed to address inequities in pay between men and women. Proponents seem to be willing to give up advantages of a market-based pay system in order to get what they think is a fairer system. (That was also the Eastern European governments' excuse.)
Battle lines between market-based and comparable worth pay systems were clearly drawn in a recent suit brought against the State of California. The claimants argued that the state's practice of paying wages and salaries based on the market discriminated because it resulted, for example, in custodial helpprimarily malesearning more than clerical helpprimarily females. The claimants were clearly arguing that the market should be replaced by a fairer system.
On Oct. 4, 1989, the judge decided the California case in favor of the market, but that doesn't end the battle. As recently as Oct. 17, 1989, the New York Times reported a strike at Hofstra University over the comparable worth issue. And, comparable worth has gained some ground, especially in government.
I believe, though, that comparable worth is a bad solution to a misdiagnosed problem. Let me explain why by first describing how each pay system worksor doesn'tand then how proponents of each system perceive the pay discrimination problem. My views reflect my training as an economist and my experiences as a manager who has operated under both systems.
When basing pay on the market, the manager must answer a question, one that is slightly different for new hires and existing employees. In setting pay for new hires, the question is: How much do I have to pay in order to attract a person with adequate skills to the open job? In setting pay for existing employees, the question is: How much would I have to pay to replace an employee if he or she decides to quit? The answers are largely provided by market data. To illustrate how, let's see how we acquire the information for word processor operators (word processors, for short).
We first determine that the market for word processors is local rather than regional or national. We then try to determine the wage for word processors in this market.
For new hires, we survey trade schools to learn what graduates are being offered for word processing jobs, we scan the want-ads in the local papers to learn what firms are offering for word processors of various skill levels, and we talk to a sample of firms to learn what they are offering and how successful they've been in finding people at these offered wages. What we're left with is a range of salaries. We take the midpoint of the range as the market wage for a word processor of average skills. So if we want a person with above-average skills, we offer a wage above the midpoint and the reverse for someone with below-average skills.
In answering how much it would cost to replace an existing employee, we use the market data on pay but include some additional considerations. For example, we have better information about existing employees; therefore, we are willing to pay more for a proven employee than take a chance on hiring a new one whose performance is unknown. Also, since searching for and training a new employee is expensive, we may be willing to pay more to retain the current employee. Of course, when employees do not perform well, we're willing to incur the search and training costs and take the chance on new hires.
So, that's how managers determine market wages. But how does the market determine wages? The same way it determines the price for any good or service: by equating demand with supply. Demand for workers in a particular job is determined by how many workers all employers in a market want to employ at different wages, and that depends on the value these workers bring to the employers. In other words, at $10 an hour, a firm may find it worthwhile to hire four word processors, but at $20 an hour, it may find it worthwhile to hire only two and shift some of the work to other staff, such as the writers or typists. The supply of word processors in a market also depends on the wage. At $10 an hour, few people may want to choose word processing as a career. At $20 an hour more people would be willing to acquire the necessary training and, perhaps, switch from other careers. The market wage is determined by the balancing of demand and supply.
Market wages continually adapt to reflect new demand and supply conditions, rising when demand for a particular type of worker grows faster than supply and falling when the reverse is true. In the last three years, for example, as more and more firms acquired the capability to do word processing, the wage for word processors increased more than twice as fast as the average wage in our local market. Changes in market wages prevent shortages or surpluses from occurring for particular jobs by changing the incentives of both employers and job seekers. Market wages play an important role in allocating workers where they are most needed. Firms look at wages to determine how many workers to employ in each type of position. Individuals look at wages to determine which careers to pursue. Market wages, by balancing the demand for workers with the supply, ensure that the interests of employers and workers coincide.
Wages determined by a comparable worth system will, in general, be different from market-based wages, because this type of system does not consider the demand for or the supply of workers for a particular job. Instead, it bases wages on the attributes of each job.
Under a comparable worth system, a group or individual, which I'll call a job evaluation committee, determines the relative value of different job types by awarding points to job attributes. Pointsmaybe from 1 to 10are awarded for such things as education and training requirements, responsibilities over valuables, management and supervisory tasks, and long-term planning duties. The committee then adds up the points in some fashion for each job it evaluates and places jobs with similar point totals in a single job grade. The committee's judgment is required at each step: which attributes to consider, how many points to award for each attribute, how to weight points for different attributes, and where to draw lines between grades.
Salary ranges then are determined for each job grade. The ranges likely encompass the market wages of every job in a grade. According to the comparable worth system, if custodial and clerical workers are in the same job grade, they should be paid the same. This wage generally differs from the market-based system, because the latter doesn't force this equality.
If the comparable worth system generates a wage below the market wage, a firm has problems. It will be unable to attract workers with adequate skills, and it will lose existing employees to other firms or institutions. In order to keep positions filled, managers must go to the job evaluation committee and fight to get more points for the job so that the wage for the comparable worth system is as high as the market wage. When the comparable worth system generates a wage above the market wage, the firm has a different problem. Naturally, a manager finds it easier to attract and retain workers. The problem is that if a firm pays higher than market wages, it is put at a competitive disadvantageunless comparable worth were to become universal, as its advocates wish.
The economic costs of comparable worth are those associated with any bureaucratic system. There are costs to running the system, in this case the meetings and deliberations of the job evaluation committees and the appeals of managers. There is the failure to adapt promptly to change, since job attributes change much more slowly than do conditions in the market. And to the extent comparable worth systems become more prevalent as their advocates wish, they cause shortages of some types of workers and surpluses of others. All these economic costs are potentially huge, as countries with bureaucratic systems have found out.
Comparable worth advocates would argue that their system, despite some potential costs, is necessary to combat discrimination by employers against women. As evidence, they point not only to a multitude of court cases proving that such discrimination exists, but also to data indicating, for example, that women on average are paid far less than men and pay for positions traditionally held by females is less than that for male-dominated positions. However, in attributing these pay discrepancies to employer discrimination, the comparable worth advocates misdiagnose the problem.
While there is no disputing that some employers discriminate against women, there are two good reasons to question whether employer discrimination is responsible for the pay discrepancies. First, such employer discrimination would have to be universal. Otherwise, if male and female workers were identical in every other way, and female workers were paid only 70 cents for each dollar paid to male workers, firms that don't discriminate could hire all the female workers they want at say, 85 cents to the dollar and drive their discriminating counterparts out of business. The market would work to eliminate discrimination, not perpetuate it. As long as all employers don't discriminate, wages would tend to even out. No one would dispute, for example, that there has been job discrimination against Chinese Americans and Jews, but because that discrimination is not universal, those two groups have been able to earn incomes above the average for all Americans.
The second reason to question employer discrimination as the cause of pay discrepancies is that when measured properly, it is not clear that such discrepancies even exist. Figures thrown around, like women making only 70 cents to a man's dollar, fail to account for many objective factors, such as the greater proportion of women working part-time, their greater frequency in and out of the work force, and their shorter average work experience. But even adjusting for such factors, there is a smaller, but still significant, difference in pay, which seems largely due to career choice. The basic question then becomes: Is it discriminatory that workers in one job, say, custodial workers, are paid more than workers in another job, say, clerical workers, if there are no bars to women working at either job?
I would answer no. Equality means equal opportunity, not necessarily equal pay. It means that equally qualified men and women entering a given occupation have the same expected income. Studies designed to measure pay discrepancies this way find that for new labor market entrants the pay discrepancies are small, if they exist at all.
Job discrimination against women does exist. A firm can discriminate directly by treating applicants for a given job differently or by treating existing employees in the same job type differently. We have laws to deal with those situations. There can also be a subtler type of discrimination when societal attitudes cause women not to enter certain professions. It hasn't been so long, for instance, since our society found it acceptable for women to become doctors. This type of discrimination should be eliminated. It harms both those being discriminated against and society as a whole. But the discrimination problem should be attacked by methods that don't mess up a system that works efficiently and tends to eliminate discriminationthe market-based pay system.