The Payoffs of Higher Pay: Elasticities of Productivity and Labor Supply with Respect to Wages

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Abstract:

When setting pay, firms trade off the potential benefits of higher compensation—including increased productivity, decreased turnover, and enhanced recruitment—against their direct costs. We estimate productivity and labor supply elasticities with respect to wages among warehouse and call-center workers in a Fortune 500 retailer. To identify these elasticities, we use rigidities in the firm’s compensation policies that create plausibly exogenous variation relative to local outside options, as well as discrete jumps when the firm adjusts pay. We document labor market frictions that give firms wage-setting power: we estimate moderately large, but finite, turnover elasticities (−3.0 to −4.5) and recruitment elasticities (3.2 to 4.2). The firm gains $1.10 from increased productivity for a $1 increase in wages. By comparing warehouse workers’ responses to higher wages both across and within workers, we estimate that over half of the turnover reductions and productivity increases arise from behavioral responses as opposed to compositional differences. These aggregate patterns mask considerable heterogeneity by gender: women’s productivity responds more and their turnover responds less to wage changes than men’s, which can lead to occupational pay gaps.

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Last updated on 12/28/2020