Excessive Wage Hikes Hurt Both Businesses and Individuals

Will raising annual salaries help improve corporate performance? There is intense debate over whether the sharp wage increases taking place in the IT sector will actually benefit companies. Some argue that they are unavoidable if firms are to secure the talent they need, while others counter that inflated labor costs will poison companies and the industry as a whole. Each case has its own circumstances, but this trend poses no small threat to our corporate culture.

Everyone hopes to earn a high salary. From the standpoint of the national economy as well, larger wage income is a good thing because it means greater value creation. But raising wages is not unconditionally beneficial. If wages are increased due to political pressure or raised excessively relative to productivity, it harms the business economy. As a result, total employment contracts across the economy, total wage income declines, and the damage becomes significant.

Wages rise over the long term along with productivity gains. A wage level formed in this way is desirable because it provides workers with more jobs and, socially, can maximize total wage income. Wages that deviate from productivity levels are difficult to sustain over the long run.

How are wages determined in the market? Just as supply and demand determine prices, wages are determined by supply and demand in the labor market. The reason IT wages are rising now is that demand has far outpaced supply. Companies facing labor shortages must secure the talent they need. There is also an aspect of a temporary boom created by the COVID situation. Fundamentally, however, this boom is also the result of an accumulated labor shortage caused by our education industry’s failure to supply the IT workforce that companies need.

The generation newly entering jobs in the IT sector places great importance on fairness. They regard it as common sense that compensation should follow performance. For their generation, the seniority-based system, in which people receive higher wages simply because they have worked longer, is not fair. For a generation that puts fairness first, annual salary systems and performance-based pay are only natural. Reflecting this change of the times, the phenomenon of wages being determined through annual salary arrangements has only just begun in our society and will spread further in the future.

The problem is that our companies operate under uniform wage systems shaped by rigid labor laws and regulations. Because firms must follow seniority-based wage structures and a hiring system divided between regular and non-regular workers, they are unable to properly reflect changing times in management.

In societies that adopt flexible employment contracts, the side effects of downward wage rigidity are not severe. This is because they can be addressed through temporary layoffs or performance-based pay. But in societies where labor unions have strong influence and wage structures are rigidly based on pay grades and steps, downward wage rigidity threatens jobs and shrinks the business economy.

If wages are excessive relative to productivity, corporate profitability declines. If companies could lower wages again, such bubbles would be resolved, but wages have downward rigidity, making them difficult to reduce. Once wages rise, they rarely fall again. There is no problem if this gap is resolved through higher productivity. On the other hand, companies that fail to secure high profitability may face the risk of being weeded out.

High salaries do not guarantee high performance. Raising wages does not increase productivity; it only hurts profitability. Companies are enduring this because securing the necessary talent has become essential to their survival. Of course, for a few highly profitable firms, the immediate burden of labor costs does not pose much of a problem. The real problem arises for the majority of firms that have failed to secure profitability. They cannot survive if they lose profitability. Wages detached from productivity are nothing more than a factor that threatens companies.

Before the social side effects grow larger, the government should move to improve institutions in ways that increase flexibility in employment and wage systems. It should also pursue educational reform to resolve the rigidity of the education system, which is failing to properly supply the talent needed in the IT sector.

Sung-no Choi, President, Center for Free Enterprise (CFE)

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Original title: 과도한 임금인상은 기업·개인 모두에 毒

Author: Sung-no Choi

Date: 2022-06-13

Source: https://www.cfe.org/bbs/bbsDetail.php?cid=press&idx=24803