Blogs | May 9, 2011

How much does money matter?

There’s much more to work than just earning money. Fairness in pay can really make a difference.

Treat me fairly
In 2011, the United States Wisconsin governor Scott Walker proposed cuts to workers' rights to collective bargaining and increases in their health insurance contributions. The changes were hotly contested. This may seem far removed from workplaces in other parts of the US and other parts of the world but it is significant. The curiosity is that workers were quicker to agree to the higher contributions than they have been to the loss of negotiating rights inspite of the higher contributions leaving them out of pocket. This suggests that fairness matters enormously in wage bargaining. Workers were furious at the loss of negotiating rights because they feel that this will deprive them of a fair hearing.

An experiment by researchers at the University of Zurich established just how important fairness is. They got pairs of people to sell tickets to nightclubs and bars, at a flat hourly rate. They then arbitrarily cut the pay of one member of the pair by 25 per cent. This had a catastrophic effect upon his effort. On average, workers suffering the cut sold 34 per cent fewer tickets.

Doesn't this just show that, if you pay peanuts you get monkeys? Well, no, it doesn't. When the researchers cut the pay of both members of the pair, sales fell by only 15 per cent – less than half as much. This shows how important fairness is. A worker who feels badly treated will perform much worse than one who suffers a more equitable pay cut. People are motivated by justice, not by wages alone.

How much do I value my benefits?
Our second curious case is the reaction to proposals in the United Kingdom to change the pension system for public sector workers. Under the plans, the age at which a person is entitled to claim a pension goes up, benefits increase less quickly and pensions are based on career-average earnings rather than on final salaries. This potentially lowers the amount received. The thing is, these proposals hit younger workers more than older ones; older workers have built up entitlements under the existing system which will not be affected. And yet opposition to them seems milder among the young than among the old. This raises a worrying possibility, that people are guilty of what economists call hyperbolic discounting.

What's 'hyperbolic discounting'
The problem here is not that we pay too little heed to the future. It's rather that our attitudes to the future are inconsistent. Which would you prefer – €80 now or €100 in a year's time? And which of these would you prefer – €80 in five years' time, or €100 in six? These two choices are, logically, identical; the latter is the same as the first, except for a five-year delay. Your answers to both choices should therefore be the same. However, some researchers have found that this is not always the case. The research shows some people prefer €80 now to €100 in a year's time, but €100 in six years' time to €80 in five. This inconsistency is hyperbolic discounting. This can badly distort our thinking about pensions and savings. A hyperbolic discounter behaves in a way that his future self will regret. The person takes €80 today rather than €100 next year. Then tomorrow, another €80 is taken rather than €100 in 366 days' time, and so on. The person never gets around to choosing the €100 in six years' time over the €80 in five. The longer-term choice that his future self would want is never chosen. Too little is saved.

I fear that the lack of hostility by young workers to the pension proposals might reflect this excessive discounting.

Get the best from your work by...
The message here is simple. Our total return from working consists of more than our pay packet. It also comprises not just pensions and healthcare benefits, but even the pay of our co-workers. And this has a couple of implications. First, if you feel unfairly treated at work, do something – consider either having it out with your boss, or moving on. If you don't, be aware your sense of being maltreated will likely affect your performance and could make it even harder for you to get pay rises later.

Secondly, when you are young – hard as it is – try to imagine being older or ill. Health insurance (for Americans) and pensions (for us all) are not something to leave until you're older. If you delay the job of sorting them out, you could well delay too long. If we exclude cases of extreme luck, the main influence upon our income in old age is how much we save, rather than how we save. And one way to save a lot is to start early.

Your older self will thank you for it.


Chris Dillow
Chris Dillow

Investors Chronicle writer and economist