March 7, 2016
The other day I was taking in my daily dose of health and safety reading and I came across the idea of “compensating wage differential”, which was first posed by Adam Smith in “The Wealth of Nations”.
You may find it hard to believe that the inventor of the invisible hand and the father of modern capitalism would be discussing the validity of workplace safety, but you’d be wrong. Not only did he write about workplace safety, he postulated a theory that modern companies can and should use to save significant payroll costs while drastically improving their EHS program.
Smith stated that in competitive labour markets, wages adjust to compensate workers for non-monetary advantages and disadvantages of different jobs. This “compensating wage differential” indicates how much the average worker values this non-monetary advantage or disadvantage.
Let’s look at an example of two similar companies. Both companies operate in the construction industry. Both companies have a strong reputation for successful project bids and provide the same competitive wage to their employees. However, Company 1 has a less effective health and safety program and has a reputation for not taking safety seriously, thereby leading to poor safety metrics and a more dangerous working environment. Company 2, however, maintains a stellar safety reputation, actively investing in employee training and technology and employs a culture whereby employees are less prone to occupational hazards.
The logic of Adam Smith’s theory would imply that prospective employees would be more interested in joining Company 2 because they’re less likely to be injured on the job. Seems logical enough, but if we take this thesis a bit further, we realize that the non-monetary benefit that the employees are receiving has a specific and measurable value.
Ok, so we know that all things equal, employees are inclined to choose Company 2 because it’s a more desirable job (more safe). However, what happens if Company 2 offered the prospective employees $1 less per hour than Company 1. Would employees still choose Company 2? What about $2 per hour? $3? The equilibrium point whereby employees are indifferent between the two companies is crucial to understand, and implies the Wage Premium required to compensate the employee for the added risk they are taking by joining Company 1.
Think about that for a second. Consider the math of this theory. Assuming your average employee makes $25 per hour and by investing in a better safety culture, future employees are happy to work for you for $22 per hour. A company that employs 100 people could, theoretically, reduce their payroll costs by over $600,000 per year! With 1000 employees, that’s a reduction of over $6 million!
Ok, so how do you go from theory to reality? It requires you to do two things:
How much would you invest in your safety program to save $600,000 annually? The first step is to understand your safety metrics and accordingly, the first investment you should make is in the ability to generate automated analytics. Then you can determine where gaps exist in your safety program and make investments to narrow those gaps.
The more effective you can be at improving your safety program, the more likely it is that you can attract employees who are willing to put a value on the non-monetary benefit that they receive by working for your company.
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