of quasi-fixed costs of labour. Unlike wages and salaries, these are cost a firm has to pay regardless of the number of hours worked by each employee.
LO2 c Learn about the distinc-
tion between workers and hours as components of the labour input, and understand the potential insights gained that way.
LO3 c Realize how important
nonwage benefits are as a share of total compensation, and see how these nonwage benefits affect the way we model labour demand.
LO4 c Learn that quasi-fixed
costs create a wedge between the value of the marginal prod- uct and the wage rate, and that this has implications for labor hoarding and other dynamic decisions of the firm.
1Seminal contributions in this area were made by Oi (1962) and Rosen (1968). Other con- tributions include Hart (1984, 1987) and Hamermesh (1989, 1995).
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Figure 6.1 illustrates the main components of total compensation and the most commonly used terminology for these components. Pay for time not worked (holiday and vacation pay, parental leave) is generally included in wage and salary income as reported by Statistics Can- ada. However, for some analytical purposes, it may be desirable to treat this as a separate compensation category. In particular, for some employees, payment for time not worked is a quasi-fixed cost in the sense that the magnitude of holiday and vacation pay to which the employee is entitled is independent of hours worked.
As is illustrated in Table 6.1 , nonwage benefits (indirect labour costs) are a large and increas- ing component of total compensation. Between 1953 and 1998, nonwage employee benefits as a percentage of direct labour costs (gross payroll) increased from 15.1 to 36.7 percent. Pay for time
FIGURE 6.1 Components of Total Compensation
Total Compensation (total labour income)
Wages and Salaries
Pay for
Time Worked Pay for TimeNot Worked
Nonwage Benefits (supplementary labour income)
Total compensation com- prises wages plus nonwage benefits. The wage and salary component can be further divided into that part directly corresponding to time worked and that part that does not depend on time worked (such as vaca- tion pay).
www.statcan.gc.ca
TABLE 6.1 Nonwage Benefits in Large Firms:1 Components and Changes Over Time
Nonwage Benefit Categories Percentage of Gross Payroll
1953 1957 1984 1989 1998
Pay for time not worked 5.9 6.7 14.9 13.9 12.4
Pension and welfare plans 5.5 6.4 9.4 9.9 11.5
Payments required by law2 1.5 2.0 4.4 5.3 9.3
Bonuses, profit sharing, other 2.2 1.3 3.7 4.4 3.5
Total nonwage benefits 15.1 16.4 32.4 33.5 36.7
NOTES:
1. Figures are for all industries. Separate figures for manufacturing and nonmanufacturing are not dramatically different. 2. Includes workers’ compensation, unemployment insurance, and Canada/Quebec pension plans.
SOURCE: KPMG Peat, Marwick, Stevenson, and Kellogg, Employee Benefit Costs in Canada (Toronto), 1989, and 1998.The last available issue is 1998.
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CHAPTER 6: Labour Demand, Nonwage Benefits, and Quasi-Fixed Costs
not worked has remained an important category of benefits, and bonuses a small component. The two fastest-growing components have been a) pension and welfare plans and b) legally required payments for workers’ compensation, unemployment insurance, and CPP/QPP.
The existence and growth of nonwage benefits are interesting phenomena to explain, especially given the basic economic proposition that unconditional cash transfers (e.g., wages) are generally more efficient than transfers-in-kind (e.g., nonwage benefits). This proposi- tion follows from the fact that recipients who receive cash could always buy the transfers-in- kind if they wanted them, but they are better off because they could buy other things if they wanted them more. Applied to employee benefits, why wouldn’t employees and employers prefer wage compensation since it would enable employees to buy whatever benefits they want rather give them something they may not value?
There are obviously a variety of possible reasons for the existence and growth of nonwage benefits. They are sometimes not taxed and, as taxes have increased over time, this increas- ingly makes nonwage benefits a preferred form of compensation. There may be economies of scale and administrative economies for group purchases through the employer of such things as pension and insurance plans. While many of these economies still could be had through completely voluntary group plans, letting people choose their benefits can be a prob- lem because of adverse selection. For instance, healthy individuals may not want to pay for expensive health or dental insurance benefits. As a result, those who want these insurance benefits will have to pay more for them since the pool of insured workers will be more expen- sive to cover as these workers will use the health and dental benefits more extensively. This adverse selection can eventually lead to a situation where insurance benefits are not provided at all, despite the fact they would be valuable to workers.
There is also the possibility that workers think they are receiving nonwage benefits free in the sense that if they did not have these benefits their wages would not rise by a corresponding amount. More likely, workers may simply prefer nonwage benefits because it is an easy way of purchasing benefits that they value. In some cases, like increased vacations and holidays with pay, it is a way of institutionalizing the increased purchase of more leisure that accompanies their growing wealth.
Employers may have accepted the increased role of employee nonwage benefits for reasons that are beneficial to them. Paid vacations and holidays, for example, enable the planning of the production process more than if the workers’ desire for increased leisure came in the form of lateness, absenteeism, work slowdowns, or turnover. Similarly, workers’compensation, unemployment insurance, and health insurance can reduce the need for employers to have contingency plans for workers in industrial accidents or subject to layoffs or health prob- lems. In addition, some employee benefits may alter the behaviour of workers in a fashion that is preferred by the employer: subsidized cafeterias can reduce long lunch hours and keep employees in the plant, the provision of transportation can ensure that workers get to work on time, company health services can reduce absenteeism and provide a check on a worker’s health, and pensions and other seniority-related benefits may reduce unwanted turnover. Employers may also prefer nonwage benefits because they provide work incentives. Employee benefits such as company pension plans and seniority-based vacation pay represent deferred compensation in that these benefits are received later in the employee’s career. Workers who leave the firm early in their careers do not receive these benefits. With some of their compen- sation in the form of deferred benefits, existing employees will be less likely to quit in order to seek or accept employment elsewhere. In addition, deferred compensation raises the cost of being fired for poor work, absenteeism, and so on, thus strengthening work incentives. These effects of deferred compensation on turnover and work incentives are discussed further in Chapter 13.
Deferred compensation can also act as a sorting or screening device, enabling the employer to hire those workers who are most likely to remain with the firm. Employers for whom
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turnover is very costly, perhaps because of the costs of hiring and training new workers, can screen out those potential employees who do not expect to remain with the firm for an extended period by making deferred compensation a significant proportion of total compen- sation, a compensation package that is most attractive to potential employees who expect to remain with the firm for a long period of time. Such screening mechanisms are especially valu- able when the employer is unable to predict which job applicants are likely to leave the firm after a brief period and which are likely to remain with the firm.
Governments may also prefer nonwage benefits (and hence grant favourable tax treat- ment) because they may reduce pressures for government expenditures elsewhere. Employer- sponsored pensions may reduce the need for public pensions; contributions to the Canada (or Quebec) Pension Plan may reduce the need for public care for the aged, at least for the aged who have worked; and increased contributions for unemployment insurance directly reduce the amount the government has to pay to this fund. In addition, many nonwage benefits are part and parcel of the whole package of increased social security, and hence the reasons for their growth are caught up with the reasons for the growth of the whole welfare state.