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Making cents of wages

Making cents of wages

Ever wonder how your wages are determined?


You’re not the only one who cares about your wages. At the Bank of Canada, we care about them a lot too.

Wages matter to the whole economy

Your wages affect both your standard of living and the bottom line of the company you work for.

Across the economy, wages affect

  • how much Canadians spend, save and borrow;
  • how much governments raise in taxes to spend on health care, education and other services; and
  • the overall costs of companies and, therefore, their production and pricing decisions.

So, it makes sense that we, as a central bank, care about your wages. Wages affect inflation, and inflation is at the heart of monetary policy.

Determining wages—the basics

Wages are determined by the combination of companies’ need (or labour demand) for workers and people’s willingness to work (or labour supply).

Labour demand

When companies decide how much to pay you, they keep a few things in mind.

What price they can charge for their products

That price must at least cover the cost of making a product or delivering a service. Higher prices generally mean companies can pay higher wages.

How productive you are

The output you can produce in a certain amount of time—we call this labour productivity.1 More productive workers tend to earn higher wages.

Many factors affect your labour productivity:

  • your education, skills and experience;
  • equipment and tools you have access to; and
  • technological progress.

Improvements in technology help increase productivity but don’t always benefit everyone. Some people’s jobs are disrupted by these advances in technology. But overall, gains from better technologies help increase Canadians’ living standards.

How many companies are hiring

When the economy is doing well, more companies compete for workers. This increased competition for workers tends to result in higher wages.

Labour supply

Like companies, you keep a few things in mind when you decide on the wage you’re willing to accept.

  • Cost of living—naturally, you want to get paid at least enough each year to cover any increases in your cost of living.
  • Work-life balance—everyone is different, and you may put more importance on your commitments outside of work, whether that’s your family life or your pickup hockey team.
  • Education, experience and skills—you want your pay to reflect the qualifications you bring to the job.
  • Attitude toward risk—the value you place on job security. Population aging may be an element of this. Some evidence suggests older workers put greater importance on job security than seeking raises or other opportunities.

You can control some factors

You’re more likely to ask for a higher wage when you

  • have a higher cost of living;
  • place greater value on work-life balance;
  • have more sought-after education, experience and skills; or
  • put less value on your job security.

Others, you can’t

For example, if more people are looking for the same job as you, the wage for that type of work will be pushed down. The most important factor affecting the number of people looking for work is how fast the working-age population grows.

When supply meets demand

Some interesting facts about the labour market can be explained by the way supply and demand interact:

  • The demand and supply of labour differ across various job markets. Wages tend to be higher in sectors where productivity is higher. This is one reason why wages can differ across the economy.
  • Over time, the average wage in the economy tends to rise at about the same rate as inflation plus the rate at which labour productivity grows.
  • The average wage in the economy rises faster than this combination of inflation and productivity growth when the economy heats up. This leads to greater inflationary pressures.

There is a strong relationship between wages and productivity across various industries.

Labour market power

These basics provide a foundation to help you understand how wages are determined. But other factors need to be kept in mind. One important factor in the real world that goes beyond the basics is the potential for exceptional labour market power to affect wages.

Labour market power basically means how much influence companies or workers have over wages. Since both can have some degree of market power, let’s talk about how this matters for wages.

Companies

Companies have market power when labour demand is concentrated—for instance, when there are only a few major employers in a specific region or looking for a given skill set. The result: less competition for your labour. This lack of competition can result in lower wages.

You may even have noticed that your employer added a “non-compete” or “no-poaching” clause in your contract. That’s another way companies can exercise their market power—by limiting your opportunities with other companies.

Workers

Workers can have market power, too. For example, if you have a highly specialized skill set, you can demand a higher wage.

Unions can also help increase workers’ market power by improving the collective information and bargaining power workers have during negotiations with companies. This raises wages.

Some factors lower the market power of workers.

One example is globalization. It leads to higher productivity and income for Canadians overall. But this also means some of us are now often competing for jobs with people in other countries, lowering the labour market power and wages of some workers.

In a nutshell

So, as you can see, lots of factors go into determining wages. Understanding these factors pays off—for you, companies and us here at the Bank of Canada.

  1. More precisely, Statistics Canada defines labour productivity as real gross domestic product per hour worked. []

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