Wage Drift

What is Wage Drift?

Wage Drift is the difference between the wage actually paid to a worker and the wage negotiated. It can be defined as the difference between the wage rates negotiated by a company and the wages actually paid to the workers by the end of the period.

Causes

• Overtime – Overtime is when the company asks its workers to provide extra hours of work to meet high demand or other requirements. The company must pay its workers an amount more than their base salary for the number of overtime hours contributed. Overtime is paid only if the wage negotiated does not include the overtime component.
• Bonus Payment – Bonus is the amount of salary paid over and above the wage. The bonus amount can be specific or on an hourly basis. Bonus payments can be for a worker outperforming in his work or for all workers when a company achieves a goal on or before time.
• Shortage in the Workforce – Wage drift can also happen when the company is unable to hire new or extra workers due to a shortage in the labor market, so the current workforce needs to work longer shifts.

Ways in which Wage Drift can Occur

1. As noted, the earnings of a worker may increase due to overtime or other factors. The occurrence of wage drift can be due to a resulting increase in the final payment of salary.
2. Wage drift can also occur when the salary or wage paid remains the same, but the workforce was underutilized. This can happen when there is a reduction in output, but the wage remains the same. Thus, the per unit cost of the company rises.

Disadvantages of Wage Drift

Wage drift provides a worker with a higher wage rate than the national wage rate upon which the salary or wage was fixed. However, it can be a disadvantage from a company’s point of view. It makes it difficult for the company’s human resource department to precisely predict and fix wages. Factors that generally cause a problem include non-controllable factors such as a sudden increase in market trends, due to which there is an increase in demand for the product.

Analysis of Wage Drift in the Euro Area (1998-2013)

_{Source: Macroeconomics by N. Gregory Mankiw (2016)}

In the graph above, it can be seen that the wage drift in the euro area is an aggregate measure and is subject to a number of factors. It indicates a cyclical adjustment in the area. The change in inflation and wage growth is typically not indicated by the negotiated wage. Thus, wage drift is used to show the change and growth.

_{Source: Macroeconomics by N. Gregory Mankiw (2016)}

It can be seen in the graph above that the wage drift in the subdued growth period, i.e., 2003-05, caused a downward effect on the compensation per employee. On the other hand, during the financial crisis of 2008, wage drift led to an upward impact. This shows that tightening labor markets make wage components like overtime and bonus pay increase more quickly than the basic salary or pay. During the downside period, wage drift went on a decline, with a negative percentage of growth in the compensation per employee. In 2010-13, wages were relatively balanced as a percentage of the overall labor cost.

More resources

To learn more about related topics, see the following free CFI resources:

• Cyclical Unemployment
• Phillips Curve
• Consumer Surplus Formula
• Inelastic Demand
• See all economics resources