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Performance pay and ethnic earnings

By Colin P. Green, John S. Heywood, and Nikolaos Theodoropoulos

The British labour market shares two important trends with that in the United States. Wage inequality has increased dramatically since the 1980s and there has been increased use of performance pay, earnings that vary with worker job performance. These twin trends have generated concern in the United States that performance pay causes certain groups in society to ‘lose out’ in the labour market. Indeed, research suggests that the earnings gap between white and black Americans is far larger among those receiving performance pay than among those receiving time rates.

Diversity and Teamwork

Performance pay provides employers the opportunity to pay workers doing similar tasks differing amounts and as a result it may influence white versus non-white earnings and the extent of wage discrimination. On one hand, tying wages directly to worker’s output should reduce the prospect of discrimination. Simply put, paying two workers of different ethnicity who produce the same amount differing wages makes discrimination quite obvious. The first guess then might be that increased performance pay should reduce discriminatory behaviour and close the earnings gap. On the other hand, much of performance pay comes as bonuses based on subjective judgements or easily manipulated standards. Critically, performance pay may differ across the earnings distribution as at the bottom performance may be easily quantified and rewarded using, for example, piece rates. At the top, the duties of a professional or manager may have many dimensions that are not as easily quantified and tied to rewards. Thus, it is important to examine the role that performance pay has at different places in the distribution of earnings.

The new research for Britain uses data from 1998 to 2008 to show that non-white men who receive performance pay are actually paid more similarly to white male workers. This is most pronounced for those who receive bonus payments. Moreover, at higher wages, non-white men who receive bonuses earn roughly the same amount as their white counterparts. The influence of performance pay in closing the earnings gap appears in the upper middle portion of the distribution. Thus, at the 75th percent of the earnings distribution white workers receiving a bonus earn 2.6% more than those not receiving a bonus. Non-white workers receiving a bonus at the same point in the distribution earn 7.6% more. This difference helps to close the ethnic earnings gap among those receiving bonuses. Other evidence from the study suggests that this partially reflects high ability non-white workers choosing to enter performance pay work. Together this new research paints a dramatically different picture from that shown in the US research. It suggests that the increasing use of performance pay in the United Kingdom has served to improve the labour market fortunes of ethnic workers in Britain.

The authors are Colin P. Green, Professor of Economics at the Lancaster University Management School, John S. Heywood, Distinguished Professor of Economics at the University of Wisconsin-Milwaukee, and Nikolaos Theodoropoulos, Assistant Professor of Economics at the University of Cyprus. They are the authors of the paper ‘Performance pay and ethnic earnings differences in Britain‘, which is published in Oxford Economic Papers. The authors worked on this research during visits to Lancaster University.

Oxford Economic Papers is a general economics journal, publishing refereed papers in economic theory, applied economics, econometrics, economic development, economic history, and the history of economic thought.

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Image credit: Diversity and teamwork. By anirav, via iStockphoto.

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