Let's say I'm otherwise happy at my job. Maybe if I interviewed I could make more but things are going well at current job and I already make quite a bit of money.
Then my employer gives me an obvious paycut via inflation. I get pissed off and decide to go through the trouble of interviewing and getting another offer. After getting my offer, assuming I even decide to give the person who tried to stealth paycut me a chance to counter, their counter offer ceiling is going to be determined by the same stingy HR department that just tried to give me a paycut, and its probably not going to be as big a raise as the offer I already have from elsewhere. And I've already done all the onerous work of interviewing and negotiating so there is really nothing holding me back from just moving on.
Meanwhile, that employee you probably should have fired should still get fired even if he makes a little less in real terms, and he's staying put but also pissed off too.
The problem is you need your mid-level performers, and anyone adding any positive value is tough to lose. People with options will jump if they get a pay cut. Any raise below 9.1% is a pay cut. Rewarding performance too much will make your org dysfunctional, you need retention above 75% per year or you wont be able to get anything done.
The more competitive the labor market the more options people have. in my experience few folks are net negative. Imagine performance goes from +10 to -10. Most workers are between 0-5, very few workers are negative. Very few are above 5. Losing a 2 for 4 months, while you rehire means, even if you get a 3, it would take 7 months to get back to even on a productivity scale. Plus if you just hire another 2 you never get it back.
Sports ball analogy. Not having a left fielder would suck when balls are hit that way. Maybe you shift right and center and try to cover the whole outfield that way, now total productivity is down because those two lose some efficacy . A Left fielder who only catches the ball 1/2 the time is much better than no one, now Right and center who are good fielding can focus on there area. Hiring only A players isn't always an option unless you are the yankees, and can spend a bunch.
The "retaining workers" thing is absolutely real, especially right now. Newly created job openings DO often update salary for inflation, so I think the physical method that lots of (highly effective) workers are currently using to claw back some of their losses from inflation are: moving to a new job that pays >9.1% more, rather than persuading their boss to give them a raise. If you can actually tell who is effective, it's more efficient to build a new team (if you had to anyway) of pre-filtered effective people and then pay them all more, avoiding the morale issues.
You are describing the key to Netflix‘ success: they use something called „the Keeper Rule“, would you fight tooth and nail to keep this colleague? If no, let them go with a generous severance package. If yes, pay them top-of-market rate + extra.
A couple of complications, one technical, one with a moral aspect.
- Managers often don't have a very clear an idea of who is and isn't pulling their weight.
- "20% of the people create 80% of the productivity" is something that's often bandied about blogs like this one. And no doubt there's a lot of truth to this. But it's not true in the sense of 20% of fruit pickers picking 80% of the fruit. It's true in teams and companies where there's a need for decisions to be made and specific pieces of work to be done. Everyone can't all do the important stuff, and having the important stuff concentrated works well for discussions and making decisions and people knowing what's happening. Or it's true where the guy who plows the field is doing more than the people use scythes to collect the harvest... It's not hard work or talent of the people producing more that's the *main* thing, it's just that they're doing the more productive bit of the job. People don't feel it's fair to have full marginal product reward system in these situations and the resources deployed towards getting a given position if/where you do are unlikely to be efficient. (See the Caplan's own case against education).
A common example. Bosses and politicians are often criticised for keeping everything within a small team at the top. Whether this is good or not, their decision in this respect has a big effect on how productivity is distributed amongst employees.
If I understand correctly, the across-the-board increase (at GMU at least) is for this year only. Next year there will also be an increase but it will be tied to performance ("scaled based upon performance reviews as we work to strengthen our performance-based culture"). So it would seem they are trying to balance morale and merit considerations...
Wow "Compression is the fundamental reason why firms prefer abler workers." - I never thought of it that way but it's a good question to ask and seems a plausible answer.
In startups, there is very heavy emphasis on only hiring top tier talent. Partly because this allows for a smaller team, which brings great communication/speed benefits to work. In principle, I suppose these benefits should be accrued by the employees, but are not.
Another interesting thing that's said in startups is "One great hire is better than and less expensive than two good hires". This supports your hypothesis.
I wonder though if there are some non-linear effects (e.g. equity compensation) or perhaps a discount for working on something meaningful or a discount for learning lots or some kind of monopsony effects in small company/startup hiring - my intuition is no, but I'd need to think more.
So many interesting things to think about. One big issue is that the cost of communication grows geometrically as the size of the team increases, so new employees could add negative productivity to a team.
Bear in mind that any pay increase, general or individual, is forever (no employer actually cuts pay). Everyone expects that any period of inflation is transitory, so employers should be very cautious about responding to a period of high inflation with high COLAs. And I think they are.
The other mistake here is the view that companies are rational and value the top performers. It's actually really hard to be a top performer and not rock the boat. Companies don't like the boat rocked. It's either promotion or firing for useful people depending on the context. A 10x programmer is often useless on a large project. They will just sit around, waiting for other parts of the system to be built, and everyone will think they're an asshole. Good management is often finding top performers the right tasks, and sometimes you don't have one, and they just make the rest of the team feel bad.
This is already happening. The Atlanta Fed Wage tracker provides a pulse check of wage growth in the United States. The way it works is surveying individual workers and comparing their wage growth over time. It ranks wage works by wage growth and then the headline release is the median worker's raise (7.4% in June 2022).
But... it also provides the 25th and 75th percentiles of wage growth which were ~0% at the 25th percentile and ~20% at the top. Differentiation is happening!
Let's say I'm otherwise happy at my job. Maybe if I interviewed I could make more but things are going well at current job and I already make quite a bit of money.
Then my employer gives me an obvious paycut via inflation. I get pissed off and decide to go through the trouble of interviewing and getting another offer. After getting my offer, assuming I even decide to give the person who tried to stealth paycut me a chance to counter, their counter offer ceiling is going to be determined by the same stingy HR department that just tried to give me a paycut, and its probably not going to be as big a raise as the offer I already have from elsewhere. And I've already done all the onerous work of interviewing and negotiating so there is really nothing holding me back from just moving on.
Meanwhile, that employee you probably should have fired should still get fired even if he makes a little less in real terms, and he's staying put but also pissed off too.
The problem is you need your mid-level performers, and anyone adding any positive value is tough to lose. People with options will jump if they get a pay cut. Any raise below 9.1% is a pay cut. Rewarding performance too much will make your org dysfunctional, you need retention above 75% per year or you wont be able to get anything done.
The more competitive the labor market the more options people have. in my experience few folks are net negative. Imagine performance goes from +10 to -10. Most workers are between 0-5, very few workers are negative. Very few are above 5. Losing a 2 for 4 months, while you rehire means, even if you get a 3, it would take 7 months to get back to even on a productivity scale. Plus if you just hire another 2 you never get it back.
Sports ball analogy. Not having a left fielder would suck when balls are hit that way. Maybe you shift right and center and try to cover the whole outfield that way, now total productivity is down because those two lose some efficacy . A Left fielder who only catches the ball 1/2 the time is much better than no one, now Right and center who are good fielding can focus on there area. Hiring only A players isn't always an option unless you are the yankees, and can spend a bunch.
The "retaining workers" thing is absolutely real, especially right now. Newly created job openings DO often update salary for inflation, so I think the physical method that lots of (highly effective) workers are currently using to claw back some of their losses from inflation are: moving to a new job that pays >9.1% more, rather than persuading their boss to give them a raise. If you can actually tell who is effective, it's more efficient to build a new team (if you had to anyway) of pre-filtered effective people and then pay them all more, avoiding the morale issues.
If a manager wants their worker to quit, why not just fire them?
You are describing the key to Netflix‘ success: they use something called „the Keeper Rule“, would you fight tooth and nail to keep this colleague? If no, let them go with a generous severance package. If yes, pay them top-of-market rate + extra.
A couple of complications, one technical, one with a moral aspect.
- Managers often don't have a very clear an idea of who is and isn't pulling their weight.
- "20% of the people create 80% of the productivity" is something that's often bandied about blogs like this one. And no doubt there's a lot of truth to this. But it's not true in the sense of 20% of fruit pickers picking 80% of the fruit. It's true in teams and companies where there's a need for decisions to be made and specific pieces of work to be done. Everyone can't all do the important stuff, and having the important stuff concentrated works well for discussions and making decisions and people knowing what's happening. Or it's true where the guy who plows the field is doing more than the people use scythes to collect the harvest... It's not hard work or talent of the people producing more that's the *main* thing, it's just that they're doing the more productive bit of the job. People don't feel it's fair to have full marginal product reward system in these situations and the resources deployed towards getting a given position if/where you do are unlikely to be efficient. (See the Caplan's own case against education).
A common example. Bosses and politicians are often criticised for keeping everything within a small team at the top. Whether this is good or not, their decision in this respect has a big effect on how productivity is distributed amongst employees.
If I understand correctly, the across-the-board increase (at GMU at least) is for this year only. Next year there will also be an increase but it will be tied to performance ("scaled based upon performance reviews as we work to strengthen our performance-based culture"). So it would seem they are trying to balance morale and merit considerations...
Wow "Compression is the fundamental reason why firms prefer abler workers." - I never thought of it that way but it's a good question to ask and seems a plausible answer.
In startups, there is very heavy emphasis on only hiring top tier talent. Partly because this allows for a smaller team, which brings great communication/speed benefits to work. In principle, I suppose these benefits should be accrued by the employees, but are not.
Another interesting thing that's said in startups is "One great hire is better than and less expensive than two good hires". This supports your hypothesis.
I wonder though if there are some non-linear effects (e.g. equity compensation) or perhaps a discount for working on something meaningful or a discount for learning lots or some kind of monopsony effects in small company/startup hiring - my intuition is no, but I'd need to think more.
So many interesting things to think about. One big issue is that the cost of communication grows geometrically as the size of the team increases, so new employees could add negative productivity to a team.
Bear in mind that any pay increase, general or individual, is forever (no employer actually cuts pay). Everyone expects that any period of inflation is transitory, so employers should be very cautious about responding to a period of high inflation with high COLAs. And I think they are.
The other mistake here is the view that companies are rational and value the top performers. It's actually really hard to be a top performer and not rock the boat. Companies don't like the boat rocked. It's either promotion or firing for useful people depending on the context. A 10x programmer is often useless on a large project. They will just sit around, waiting for other parts of the system to be built, and everyone will think they're an asshole. Good management is often finding top performers the right tasks, and sometimes you don't have one, and they just make the rest of the team feel bad.
This is already happening. The Atlanta Fed Wage tracker provides a pulse check of wage growth in the United States. The way it works is surveying individual workers and comparing their wage growth over time. It ranks wage works by wage growth and then the headline release is the median worker's raise (7.4% in June 2022).
But... it also provides the 25th and 75th percentiles of wage growth which were ~0% at the 25th percentile and ~20% at the top. Differentiation is happening!