Intouch: Big pay – but not for better work

Bigger firms in New Zealand – as in other English-speaking countries – pay higher wages than smaller firms. But why?
Research by two New Zealand economists shows that there is no evidence that this pattern occurs because workers in bigger firms are more skilled than their small enterprise counterparts, as some researchers have previously suggested.
The research, by the University of Waikato’s Professor John Gibson and Dr Steven Stillman of Motu Economic and Public Policy Research, looked at wage, skill and educational levels of more than 12,000 workers in nine countries – including 1700 in New Zealand.
The researchers found that while New Zealand does exhibit the big firm premium (BFP), the effect is not as universal as often suggested. Canada exhibits the largest BFP; workers at the biggest firms there earn an average 72 percent more than those at the smallest firms. In New Zealand, as in the United Kingdom, the United States and Ireland, the BFP is between 16 percent and 31 percent.
“There are lot of hypotheses about why big firms pay higher wages,” says Gibson. “One is that big firms just hire better workers. We tested that, using new measure of worker skills – their score on literacy tests in the International Adult Literacy Survey – and found no evidence that controlling for this previously unexamined factor changes either the size or significance of the BFP.”
The findings, published in the leading Harvard journal The Review of Economics and Statistics, put the spotlight on other explanations for the BFP, says Gibson.
“Wages in private sector firms should reflect workers’ productivity, so the higher wages in bigger firms suggest that workers in those firms are more productive. If this is the case, then paying too much attention to the small and medium-sized enterprises might be counter-productive since workers in those firms tend to have lower productivity.”
On the other hand, if the higher wages in big firms reflect market power due to less competition, there may be public policy trade-off between the higher prices charged to consumers and the higher wages earned by workers.
“These debates are extremely important for New Zealand because we have very few firms of global scale and also because the Commerce Commission has been quite active in dealing with local mergers and acquisitions,” says Gibson.
The researchers say that while their work has ruled out one explanation, it’s important that follow-up research tries to tease out the productivity versus market power views. They say there is potential to do this follow-up research focusing on New Zealand firms because Statistics New Zealand collects singular database, the Linked Employer-Employee Data (LEED), containing information on the earnings of all individuals and the characteristics of the firms in which they work.
“Only small number of countries collect this sort of data, which allows us to make simultaneous estimates of both worker productivity and firm profitability,” says Stillman. “This means we can not only examine an important question in the New Zealand context, but make an important contribution to worldwide knowledge too.”