Introduction: from compression ratios to pay differentials
In an earlier post we argued that, as a summary statistic, the compression ratio can direct us to aspects of public service pay and grading that we need to understand. That is, the target we have been shooting at with compression ratios is still worth hitting, even if our habitual prescriptions of decompression have fallen wide of the mark.
Approached from the vantage point of Human Resources (HR) professional practice, pay differentials are important for motivation and performance. They are not, of course, the only contributor to motivation and performance, but they are an important one. HR professional practice tends to focus on pay differentials between adjacent salary grades, as opposed to a compression ratio for the entire salary structure.
Pay differentials in HR professional practice
Why focus on differentials between salary grades or ranges, rather than between the top and bottom of the entire salary structure? HR people have a practical interest in motivating the individual worker to maximize his or her performance. One way of doing that is by arranging pay differentials so that every grade is more attractive financially than the one below. In that way, many workers will be motivated to improve their performance in order to make themselves eligible for promotion to a higher grade.
Likewise, HR people want to prevent the worker's supervisor from growing discouraged because, in turn, he or she has ended up earning less than the worker that he or she supervises (including because that worker has been recruited at a prevailing market rate which the supervisor's pay has fallen behind).
We are assuming here that the individual worker focuses on the next grade above his or hers (or below his or hers, in the case of the discouraged supervisor). We know from research that employees are intensely interested in the salaries of people on grades just above and just below them, to the extent that they will sometimes prefer a smaller pay increase which preserves their differential advantage over another group of employees, rather than a larger increase which comes at the cost of losing that differential advantage (because, in the latter case, the other group is obtaining an even larger increase).
By contrast, workers are, typically, not very interested in the salary of the CEO up in the clouds above their heads – unless of course the organization unwisely trains workers’ attention on the issue! (Reality check: are readers of this blog who are also employees more aware of the difference between their salaries and their CEO’s salary, or between their salaries and those of the grade just above them?)
HR specialists don’t agree on what constitutes an appropriate differential between grades, in terms of offering meaningful performance motivation. Armstrong and Murlis's 2004 UK pay textbook suggests that a differential of 15-20% between grades is usually appropriate, based on an eight-pay grade structure which they regard as typical. An article from the US professional HR literature says, ‘Ideally, there should be at least a five percent difference between adjacent pay ranges.’
What kinds of things can we see, if we take a look at pay differentials in the public service? Consider, for example, the table below, which sets out wage differentials in the public service for one developing country member of the Bank.
If we look first at the column of differentials based on the salary scale, we can see that a couple of the differentials are so small that they probably do not provide a meaningful performance motivation, and that there is a very large range of differentials across the salary scale, which prompts the question of whether there is some justification for this wide variance. Overall, we could also note that most of the differentials are quite large, relative to the HR recommendations which we reviewed above. Certainly, there wouldn’t appear to be a case for general decompression here!
It is also instructive to look at the column of differentials calculated from payroll data. In terms of what is actually paid, rather than what is indicated by the salary scale, several more of the differentials are so small that they probably aren’t meaningful. One of them, at -1%, is even negative. And a few vary quite markedly from what the salary scale prescribes (21 percent becoming 32 percent, and 28 percent dropping to 13 percent). The payroll differentials highlight the need to take a look why people earn such different amounts in practice.
A final point to note, from both columns, is the relative flatness of the salary scale at the top end, apart from the lucky few who make it all the way to the top. How much richer are these insights, than those that can be gleaned from a compression ratio alone!
One more facet of HR professional practice is relevant here. In countries with fast-growing private sectors, public agencies may find it hard to retain staff whose skills command a market premium. Market comparisons and surveys are useful to specify which staff those are, rather than assume – as we have sometimes done in the past – that it is the most senior staff who will be hardest to retain, when it may be technical specialists such as IT staff whom a public agency is most at risk of losing.
At the moment, market surveys are not well established in many developing or transition economies. This may be because, in a number of them, market comparisons were simply not available until quite recently. Moreover, in the past there was often an assumption among governments that they should be pay leaders, not pay followers: it was up to the private sector to pay attention to what the public sector was paying its staff, not the other way round.
Conclusion: towards pay differentials and market comparisons
All in all, we suggest that we can get very useful pay reform guidance on pay differentials from HR professional practice. Pay differentials matter – yes they do. But they matter in the form of the differentials between grades, and between comparable jobs in the private and public sectors, rather than the crude ratio between the top and bottom of the salary structure as a whole.
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