How it arises and why IT experts earn more than waiters

People don’t talk about money – and especially not about wages. Many people are more willing to reveal intimate details of their love life than their pay slip. This is especially true in Switzerland, where it has always been considered good form to keep quiet about wages. This may have cultural reasons, especially since financial discretion is highly valued in this country. The fact remains: wages are soon next on the list of taboo subjects after death, violence and illness.

You are what you deserve

Because salary is more than just a number on the monthly bank statement. It is also a source of self-esteem. A research group led by Wiebke Bleidorn from the University of Zurich demonstrated in a representative study last year that an increase in income leads to better self-esteem. Because income is also seen as a marker of social status. This is equally true for men, women, young people, old people, academics and tradespeople. To a certain extent, you are what you earn.

But it also works the other way round. High self-esteem is not only the result, but sometimes also the cause of a growing income. People with a strong ego are more likely to push through their salary demands than someone who is full of self-doubt. This starts with having more confidence in themselves. People who are self-confident take career opportunities that lead to higher pay. Insecure people, on the other hand, miss out on such opportunities because they believe – often without objective reason – that they are not suitable for the better-paying job.

But how are wages determined? “From a company’s perspective, the decisive factor is how much added value an employee can create during their working hours in the production of goods and services,” says Michael Siegenthaler. He is a labor economist at the Swiss Economic Institute (KOF) at ETH Zurich and explains: “Companies don’t employ employees for pleasure, but to sell a product or service. And the added value that the employee contributes to the sale largely determines the wage.”

Software and daily menu

Economists refer to this added value as marginal product. This refers to the contribution that an employee makes to the company’s success. There are major differences depending on the industry: an IT specialist who is responsible for bringing new software onto the market generates more added value than a waiter who serves a guest a daily menu. Accordingly, the Swiss median wage in the IT sector is 9,400 francs, more than twice as high as in the hospitality industry (4,600 francs).

These wage differences usually have little to do with personal hardship. Standing on your feet in a restaurant all day is probably more tiring than programming on an ergonomic office chair. Human capital theory attempts to explain why wages are higher in the IT sector. It puts the employee at the centre rather than the company and postulates that more investment in training and qualifications leads to higher labour productivity, which ultimately translates into higher wages.

But while good training is important, it is not enough to earn a good salary. Anyone who has learned a skill in space technology that can only be used at NASA is in trouble. Such a specialist cannot credibly threaten to move to another company during a salary negotiation at NASA. “Pay also depends on whether your skills are in demand by many companies,” says Siegenthaler. Mobility, i.e. the willingness to move to a new place for a job, is therefore also important.

Performance is hardly measurable

It sounds plausible that an employer pays an employee as much as the added value they deliver. It is also plausible that someone with better training can create more value and therefore earn more. However, reality is far more complex than these “neoclassical” models, which assume that the balance between supply and demand in the labor market is established by the level of wages. In the real world, the information needed to calculate the market-clearing and therefore “correct” salary is often lacking.

This begins with the measurement of the value of a worker. “Scientifically, it can be shown that performance assessments are extremely flawed and distorted,” says Antoinette Weibel, Professor of Human Resources Management at the University of St. Gallen. She explains: “Apart from assembly line work, where productivity is easy to measure, performance is almost impossible to quantify.” After all, performance does not only include contributing to profits, but also, for example, helpfulness, creativity or the ability to ask uncomfortable questions.

“We should recognize that meritocracy is only an ideal and that our wage systems are far from the ideal of performance-based pay,” concludes Weibel. This is particularly true for top salaries for CEOs. These can hardly be explained by reference to market forces or by the argument that only very high salaries attract the best talent. “Around 70 percent of CEOs are promoted to the CEO’s chair internally. The alleged market here is therefore not particularly lively, but rather manageably small,” says Weibel.

More profit thanks to higher wages

However, average earners often also benefit from wages that are above the market wage. The explanation for this is the efficiency wage theory. It states that it can make sense for companies to pay more than the wage at which supply and demand are in balance. This is because a better wage increases the motivation of workers and leads to higher productivity. Here, the causality is reversed: the employee’s performance no longer determines his wage, but the wage determines the employee’s productivity.

Henry Ford is often cited as an example of this observation. In 1914, the American car manufacturer unexpectedly doubled the daily wage of its employees to $5, which was far above the average wage of $2 to $3. The result: employees worked harder because they would have earned much less if they had been laid off elsewhere. Output increased, sick leave decreased, and profits soared. Or to put it in Henry Ford’s words: “Paying good wages is not charity, it is the best business.”

The episode shows that seeing wages as a flexible result of supply and demand is too simplistic. Wages are astonishingly rigid. In a recession, hardly any company dares to reduce wages. There is a great fear that the good employees, who can easily find a new job, will leave the company in frustration and the company will be left with the bad workers. The danger of such “adverse selection” leads to layoffs rather than wage cuts. Wages are also sometimes taboo for employers.