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Introduction

Wage ratio caps prevent the wages of all employees from exceeding a maximum of a fixed multiple of the wages of the lowest paid employee in a given institution.

Wage ratio caps can apply to both the public and private sector. In some places they have been introduced as company policy. Though they are yet to have been implemented, they have also been proposed as legislation in some countries.

Question

What effect does a wage ratio cap have on the efficency of allocation of labour?

I'm having difficulty with comparing this to other policies which directly represent price ceilings.

I see one main difference with pay ratios: companies can always compete to provide high pay for their executives. A company can always offer a more competitive wage for its executives by paying its lowest earning workers more. This is different to price controls like a rent control, where a landlord does not have access to a lever which raises the rent they can charge.

I would accept an answer that can show that the policy has the same effects as a price ceiling, but I'd also like to see explanation of the consequences for the labour market.

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  • $\begingroup$ See price ceiling $\endgroup$
    – Herr K.
    Jan 27, 2018 at 21:56
  • $\begingroup$ @HerrK. Thanks, I've edited the question to include price ceilings. $\endgroup$
    – geo
    Jan 28, 2018 at 19:41

1 Answer 1

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The effects can be quite different from a price (wage) ceiling. The baseline case where you have homogeneous, inelastically supplied labor that's free to move across different "types" of work produces no supply response in reaction to a wage ceiling, but leads to complete specialization in one type of labor or another in the case of enforced bounds on relative wages which rule out the competitive market allocation.

For companies, enforcing internal wage ceilings may be a way of trying to address problems of corporate governance - the shareholders may be trying to address a principal-agent problem by getting such a policy instituted within the company. In that case, it may well improve efficiency, but it's hard to say if there would be a significant impact on the supply of executives available for corporate management.

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