Wage differential refers to differences in wage rates due to the location of company, hours of work, working conditions, type of product manufactured, or other factors. It may be the difference in wages between workers with different skills working in the same industry or workers with similar skills working in different industries or regions.
A wage differential, which is also called a compensating wage differential or an equalising difference, is defined as the additional amount of income that a given worker must be offered in order to motivate them to accept a given undesirable job, relative to other jobs that worker could perform. One can also speak of the compensating differential for an especially desirable job, or one that provides special benefits, but in this case the differential would be negative i.e., a given worker would be willing to accept a lower wage for an especially desirable job, relative to other jobs.
The idea of compensating differentials has been used to analyse issues such as the risk of future unemployment, the risk of injury, and the monetary value workers place on their own lives.
Types of Wage Differentials
(1) Employee’s Character-Based
Employee’s character can be defined as job matching personality, i.e., the type of occupation, level of skill and knowledge, working attitude, and extent to which he/she can do the work independently. They can be classified as –
(i) Skill-Based Differentiation – The wage difference among different degrees of skill of the workers appears in these differentials. Skilled workers on an average earn more than semi-skilled, unskilled, and casual workers in any industry and in any state or country. Generally, companies have found it necessary to widen the skill differences to attract the requisite skill-holders.
(ii) Gender-Based Differentiation – Generally, some of the jobs may need a masculine role and some may need a feminine role for its effective performance. These considerations employ women for some roles and only men for some roles, but because of the difference in the capacity to work the compensation differ accordingly, creating compensation differentiations.
(iii) Experience-Based Differentiation – The entry-level wage or salary needs a rise when the employee gains experience in doing that job, develops expertise and can improve the quality and productivity. This rise may vary according to the level of excellence achieved, level of degree of supervision needed, and the number of years of experience. Such differentiations are referred to as exprience – based differentiations or extent of supervision-based differentiation.
(iv) Work Behaviour-Based Differentiation – The extent of efforts required to perform any task or work also vary, which necessitates wage/salary differentiation. Some may require manual work, some may require mixed efforts of machine and hand and some may require automation only to be supervised or monitored. Secondly, the complexity of work also makes differentiation in pay packages.
(v) Occupational-Based Differentiation – These are based on skill, experience, and training taken by the employees. These may be inter-plant, inter-industries, and inter-regional also. Inter-plant differentials imply the differences in pay for the same or a similar job in the same industry, while inter-industry differentials are for the same or similar jobs between industries in the same locations or in the same labour market at the same time. They are the pay differences for the same kind of input.
Normally, the compensation differences are due to the different living standards and the working conditions in the area where the industry or the business is located. The availability of manpower or the supply to demand ratio is another factor for regional wage differentials. In some of the cases, the workforce for the same occupation may be coming from different neighbouring locations and are paid differently. Compensation payment also varies according to the geographical, regional, and state’s economic development stage or standard of life in the area such as –
(i) State-Based – Similarly, the state’s economical and social standards may vary. The minimum wage concept may be different and so the varying pay packages.
(ii) Country-Based – National socio-economic needs also affect the need for employment. The development stage decides the labour rates and the type of resource availability, which result in wage or salary differentiations.
(iii) Geographical-Based – The economy of the regions varies according to their geographical location and resource availability. The standard and nature of living influence the needs or expectations of the person of that location and so the compensation.
(i) Inter-Industries Compensation Differential – These differences arise when the workers in the same occupation and in the same area at the same time are paid different compensation packages in different industries in the same location.
(ii) Intra-Industries (Inter-Plant) Compensation Differential – In the same plant or industry, the employer may pay different compensation packages, based on differences in the quality of work, quality of labour, imperfection in the market, and differences in efficiency of plant or machinery.
Importance of Wage Differentials
(1) They provide incentives for people to undertake less desirable work. If society decides that resources need to be allocated to production that involves undesirable work, then compensating wage differentials are necessary. Without extra wages, this work is not done.
(2) They provide incentives for employers to reduce the undesirable nature of the work. If otherwise identical firms have different working conditions, then one is forced to pay higher wages to attract workers. Higher labour cost encourages employers to improve working conditions to remain competitive.