Does higher pay result in greater productivity?
Henry Ford paid his workers $5 a day, twice the average for the car industry. Instead of setting a high selling price and keeping wages and costs low, Ford incentivised his workers to increase production and reduce costs based on economies of scale. As a result, the price of a Model T fell from $950 in 1908 to just $290 in 1927. At the height of the Model T’s popularity, Ford’s factory was turning out one car every 24 seconds!
In this very famous example at least, higher pay resulted in greater effort.
But in today’s complex market economy this simple equation cannot be taken for granted. Paying more than the market rate is no guarantee of reciprocal effort on the part of the employee or supplier. Monetary reward alone is no guarantee the work will be carried out to everyone’s satisfaction.
Professor of Behavioural Economics at Harvard Business School, Matthew Rabin, theorised that people can be moved by a motivation to be kind in response to kindness and unkind in response to unkindness. Intuitively, many think of trust and trustworthiness as reciprocal actions in this sense, as reciprocal kindness.
But Robert Sugden, of the University of East Anglia, and I argue that economists are mistaken in using the concept of kindness to try to explain co-operation. When an employer pays a higher wage, they are not being gratuitously kind, nor are they always seeking to maximise profits. They are simply trying to initiate a relationship of mutually beneficial co-operation. If a worker responds by putting in extra effort, he or she is not rewarding their employer for a meritorious action; they are joining in the co-operation they have proposed.
To illustrate this, we have come up with a model situation that we call Trust World. A Trust World is one in which every first mover trusts the second mover, and the second mover behaves trustworthily. They are following what Sugden in his recent book, The Community of Advantage, calls the ‘Principle of Mutual Benefit’: each is playing his or her part in a voluntary scheme from which they both benefit.
Take the example of a contractor who you pay to decorate a room in your house. You trust them to do the work while they trust that they will get paid. Is the person doing the work being kind to the homeowner? And is the homeowner being kind in return?
This is how the situation would be interpreted using Rabin’s model of reciprocal kindness. It may be true that sometimes the job turns out badly and you refuse to pay the agreed price, but in the overwhelming majority of cases things go according to plan. When things go well, the situation is similar to Trust World. If the contractor is certain they will be paid, their doing their work is not a kind act, and so does not deserve kindness in return.
Under the reciprocal kindness view, the paradox is that if the trust isn’t seen as an act of kindness then it won’t be responded to by kindness. If, for example, an employee is suspicious that the reward he or she is being offered is part of a sophisticated strategy on the part of the employer for increasing profit, according to the theory of reciprocal kindness they will not necessarily reciprocate by working harder.
In this instance, an employer acting in their self-interest would provoke the employee to also act in their own self-interest and refuse to make additional effort. If higher wages elicits more effort, it must be because they make trust and trustworthiness mutually beneficial. We prefer to think of trust and trustworthiness in terms of reciprocal co-operation.
There are many situations in which reciprocal co-operation may play a role. Think about the pay structure in modern organisations. Bonuses are often used to reward innovations, but evidence suggests that for highly involved, creative and productive jobs, such conditional incentives may backfire.
To the contrary, ensuring that workers don’t need to worry about money may be more effective when they are passionate about their jobs and value their autonomy. The reciprocal co-operation interpretation is that the workers and employer enter a co-operative relationship in which employers motivate workers with conditions that value their skills and respect their autonomy, while workers put those skills at the service of the organisation.
Unlike the logic of reciprocal kindness, based on the principle that people go about rewarding and punishing others, the logic of reciprocal co-operation offers a more positive view of interpersonal relationships by emphasising the great potential that lies behind the realisation of mutual benefit.
Issuing a pay rise might not always result in increased productivity, but, according to our theory, it may fuel mutual co-operation that could lead to long-term benefits for the organisation.
This article was originally written by Andrea Isoni and originally published on the Warwick Business School website, whose London location at The Shard offers an ideal base for executive learning including an Executive MBA and a range of executive diplomas.