How do I tell if my wage is a "good deal"?

A good mate of mine sent across the following question:

"How can you tell if an offer is really good or just average if it seems really good compared to a poor baseline?"

This is a good question, which touches on a whole series of points about how wages are determined, bargaining, wage dynamics, and expectations. However, there is a core component that we can grab a hold of here to try to wok out what “good” means and start to unpack this question - specifically asking how we can compare wages between jobs.

So I thought we could expand some of our prior points about lawnmowers and discuss this question a bit here.

tl;dr If you want to understand whether a wage offer isn’t good enough you can do things i) look at what you’ll get offered in another job ii) look at how quickly the firm hires and loses staff/how long a vacancy sits open.

If other jobs you could receive offer you a similar work life and a higher wage, and vacancies sit open for a while, you have a good shout to complain about the offer - otherwise you might be imagining a bit of a “grass is greener” type thing.

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What is a job

A job is the thing we do for someone else in return for income, which we then use to buy goods and services. From our own perspective we are selling our time in order to get some money.

But it is useful to take a bit of a step back. For this job to be available someone needs to be valued by the person who pays them.

The way we’ve previously chatted about this is in terms of tasks and skills. When someone hires you they need you to do certain productive tasks that produce value output. Your ability to do these tasks efficiently depends on the skills you have available.

Some skills are transferable - they can be used to do tasks across a variety of potential roles. Others are not, they are specific to either the type of job or even the specific employer you are working for.

So this leads us to a way of thinking about how wages are determined - which is the first step for asking whether the wage is a “good deal”. An employer demands a bundle of skills from employees with which they can produce output, while an employee supplys a bundle of skills.

Here, the employer would not pay more than the value generated from the tasks performed. And the employee would not accept less than their opportunity cost (which they could do with their time in another job or at home).

Both of these employer and employee reservation values are positively related to how well skills translate into output. As a result, the first way we can understand whether a wage seems good would be to look at the return to such skills.

Deconstructing wages - returns to characteristics

Using this logic, one thing we can do is estimate the return to skills for individuals. Assuming you’ve been provided a copy of STATA, or have made yourself familar with R, you can use some earnings data to work out whether your pay day looks good.

The starting point for this is the Mincer Earnings Regression, which was used to estimate individual wages as a function of education and work experience.

However, the literature has moved a long way forward - as we now have more information about i) the actual skills embedded in educational outcomes ii) the skills required to achieve tasks in different jobs iii) the degree of substitutablity between different occupations. The use of both education and surveys of skills to estimate returns is well explained in this paper.

We’ll leave all the complications for researchers to look at in their studies - our goal is to think about how we could interpret others estimates to understand if a wage offer is “good”.

The first step would seem to be the following:

1. Estimate a wage equation based on a set of everyones individual skills - one with their occupation and industry and one without (to allow you to think about whether there is a penalty associated with being in an industry or occupation - and whether you are ok with being in that penalty to be in that sort of just).

2. Look at the expected return from those skills for someone with similar skills to you.

3. See if the wage that suggests is lower or higher than the one you are being offered.

Job done. Except we can’t actually see a lot of skills - we’ve all worked with people who appear to have exactly the same CV, but one of them is clearly a better employee than the other.

If we have panel data (data that tracks a bunch of individuals over time) then we can incorporate individual level fixed effects - these represent the return to unobserved skills that do not vary through time. [Note: Truly estimating returns to skills is a lot more complex to this - the introduction to a paper I was reading recently explains this very well.]

Now there is something we really want to know here - do all these returns to skills reflect what I could earn if I floated off to another job? Not necessarily - as we may be in a job where our skills are super valued, or at an employer that is more productive or more genorous with their pay structure.

For that we need to correct for employer based pay policies (firm fixed effects) or the special way our skills may match what our employer needs (match effects). I really nice discussion of this is here.

Our we’ve accounted for all of these things we have an estimate of portable earnings - or the amount we could earn if we head to some other job. Compare what we are getting offered to this amount, and we’ll have an idea of whether this is a “good deal”.

But one warning. A firm may pay less because the workplace is more flexible, more relaxed, or is focused on a friendly culture. If there are positive non-wage amenities from the job this will not be captured in the wage regression.

Revealed preferences

What we’ve discussed above is very data intensive - and to be honest we just don’t have a lot of the data! So is there something a bit simplier we can do?

Well for jobs where there is some portablity, we can just look at whether businesses are able to fill roles.

Does it take forever for your employer to hire someone - especially compared to “similar firms”. Do people quit relatively often? Are there always a large number of empty jobs? These are all other rationing devices making up for the wage being too low to attract and retain staff.

This concept allows us to use information about job flows to understand the balance of supply and demand for jobs. Adding in flows allows us to also think about the second part of the question - whether individuals might be happy with a pay rise, even though it “isn’t enough” (something that can undeniably happen!).

However, if there was no shortage then the idea that an individual may view a pay rise as good, even though it is less than is appropriate - doesn’t really fit into this. If pay was already “too low” there would need to be a developing or existing shortage of workers. If it is “too low” in this context, then the developing or existing shortage would continue to persist going forward.

Now defining the shortage does get a little more complicated. If a job offered a fixed low income, then roles may be filled by those with low portable earnings (i.e. those with insufficent skills for the role), implying that the headcount is filled out … but the people doing the job are relatively unproductive.

If you feel like you are in a job where everyone around you is just collecting a paycheck and achieves very little, then this could be a symptom of the wage offer being pretty average.

Concluding

Hopefully these two approaches have provided a bit of a framework to think about whether a wage offer is “good”. There are always trade-offs in life, and trying to work out the costs and benefits for working is important - the circumstance where a new employer is better in every dimension isn’t as common as we imagine, and is only clear when you go out and take a chance.

I also don’t want to overstate the importance of money returns - having an income to live is of course of primary importance, but valuing those you work with, and being treated with respect as a colleague are real and important things.

What both approaches tell you is that it is important to understand what options are available to you. Just like any relationship, in an employment relationship mutual respect between the employer and employee matters for the relationship to last. If your employer is underpaying you relative to other employers with compensating you with a pleasent workplace, flexibility, and/or the chance to work on things you care about (i.e. getting to spend every day doing economic research <3 ) then don’t feel bad about looking around at what else is available.