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OPINION

Pay and productivity

Pay and productivity
October 19, 2017
Pay and productivity

Productivity matters because it is a basic building block of prosperity; without rising productivity among its workers, a nation will become poorer, with the problems that implies. Workers become more productive when they produce more output for a given amount of input; usually output per hour worked. By inference, something similar happens to companies – they become more productive when they generate more ‘value added’ per employee, much the same as gross profit per employee.

Writing in the Harvard Business Review, Eric Garton, a partner at management consultant Bain, comes up with the suggestion – at once both novel and obvious, provocative and debatable – that workers can be more productive if, quite simply, they are paid more. “We could improve productivity if we stopped systematically underinvesting in human capital. The most direct and obvious investment is increased wages,” he says.

In some quarters, this isn’t a new notion. We hear calls to this effect from politicians on the hardish left. Its logic is also built into the increases in the UK’s minimum wage, which, in the past seven years, has risen by almost 4 per cent year on average, well ahead of national wages.

What these diverse voices – the management consultant, Labour’s left, the Low Pay Commission – have in common is the idea that a well-paid worker is a happy worker is a productive worker. There could be more to it than that – raising pay might even bring macroeconomic benefits if it helps break what threatens to be a self-re-enforcing spiral into deflation in the developed world. That hope has driven calls for the restoration of a statutory incomes policy for the UK, and this time around employers would be compelled to raise pay above specified thresholds.

However, it’s the possible link between pay, productivity and investment returns that most interests us. Bain’s Mr Garton says that “higher investment in wages does not need to come at the expense of customers and shareholders”. He cites a New York cleaning company that paid its employees at above-market rates and found that levels of churn for both customers and employees dropped. He points out that Wal-Mart (US:WMT) is committed to spending $2.7bn (£2.1bn) on extra wages, benefits and training for its employees. Big though that figure is, for the world’s biggest private sector employer it works out at $1,900 per US worker or $1,200 per head if it has to stretch worldwide; and these two examples examples hardly constitute proof of much.

Equally, Mr Garton has a point when he says “for too long business objectives and management philosophies have focused on efficiency over productivity”. Making the machine leaner does not necessarily make it better, particularly when ‘leaner’ is management-speak for ‘half starved’. But that still leaves investors wondering if there is a connection between raising employees’ pay and share price returns.

Miserably, the data base for companies’ accounts we use here at Investors Chronicle does not include the cost of pay, which would allow us to look for a correlation between changes in pay per employee and share performance. So the table offers a little snapshot of four companies specifically chosen because they seemed likely to produce interesting results.

Predictably, the correlation between pay and share price returns for the 10 years 2007-17 was positive in the case of software and IT services supplier Sage (SGE) and negative for supermarkets operator Tesco (TSCO). Rapid expansion followed by recent troubles at support services supplier Capita (CPI) looked like producing something unpredictable; ditto in the case of utilities supplier Severn Trent (SVT), where restructuring is a way of life.

 

Pay and performance    
Compound growth in*TescoCapitaSageSevern Trent
Wages/employee2.00.24.37.4
Share price-5.1-1.911.05.1
*per cent per annum; data for 10 years to 2017; source: S&P Capital IQ    

 

For reference, in the 10 years to March 2017, average pay in the UK grew at 1.9 per cent a year compound to £502 per week, which was less than inflation of 2.8 per cent, as measured by the retail prices index. In that context, workers at Tesco did not do too badly despite their company’s fall from grace. The absence of wage growth at Capita, where employee numbers almost tripled to 75,000, was about the recruitment of cheap workers overseas. The reverse happened at Severn Trent, where employee numbers almost halved while average pay more than doubled to £40,000. That leaves Sage as the conventionally successful one – underlying profits almost doubled, per employee outstripped inflation and its share price almost tripled in the period.

Yet even here it’s guesswork to say which way causality ran. Which takes us back to where we began, saying “yes, it would be a nice thought if higher pay led to better productivity and produced good share price performance”. But perhaps it’s just that – a nice thought.