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Reasons for Wage Differentials

Paper Type: Free Essay Subject: Economics
Wordcount: 2477 words Published: 20th Sep 2021

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Wage differentials have a great economic and social significance; they are directly related to the allocation of the economic resources of a country, including manpower growth of the national income, and the pace of economic development. Social welfare activity depends, in a large measure, on such wage differentials as will:

  • Cause labor to be allocated among different occupations, industries and, geographical areas in the economy in such a manner as to maximise the national product
  • Enable full employment of the resources of the economy to be attained; and
  • Facilitate the most desirable rate of economic progress.

Wage differentials reflect difference in the physical and mental abilities of workers, differences in productivity, in the efficiency of management and in consumer preferences, and act as sign posts for labour mobility. By providing an. important incentive for labour mobility, they bring about a re-allocation of the labour force under changing circumstances. Under competitive conditions, wages are determined by conditions of demand (which reflect the productivity of workers) and conditions of supply (which reflect the attractiveness of jobs). The level of wages would depend upon the relative scarcity of supply in relation to demand. Scarcity differentials (which may be due to specific skills and mental abilities) produce wage differentials; and as long as the former as inevitable, the latter, too, would be so.

In other words, wage differentials reflect the different degrees of scarcity of the different categories of labour; and since different categories cannot be reduced to the same degree of scarcity in the market, wage differentials are inevitable.


The word differential means relating to, or showing a difference, or making use of a specific difference or distinction. Wage differential is an element of location selection that is a wage scale reflecting the average schedule of workers’ pay in an area that takes into account the performance of related tasks or services.

Wages differ in different employments or occupations, industries and localities, and or between persons in the same employment or grade. It may be termed as occupational wage differentials, inter-industry, inter-firm, inter-area or geo graphical differentials and personal differentials.


Wage differentials arise because of the following factors:

  • (a) Differences in the efficiency of the labour, which may be due to inborn quality, education, and conditions under which work may be done.
  • (b) The existence of non-competing groups due to difficulties in the way of the mobility of labour from low paid to high paid employments.
  • (c) Differences in the agreeableness or social esteem of employment.
  • (d) Differences in the nature of employment and occupations.

The nature and the extent of wage differentials are conditioned by a set of factors such as the conditions prevailing in the market, the extent of unionization and the relative bargaining power of the employers and workers. The rate of growth in productivity, the extent of authoritarian regulations and the centralization of decision-making, customs and traditions, the general economic, industrial and social conditions in a country, and a host of other subjective and objective factors operating at various levels. The prevailing rates of wages, the capacity of an industry to pay, the needs of an industry in a developing economy, and the requirements of social justice also directly or indirectly affect wage differentials.


Wage differentials may be present due to any one or more of the following:-

  • The personal policy of the employer to maintain differentiations
  • Imperfection of the labour market to take its advantage
  • Regulatory system of employment
  • Relative bargaining strengths of employees and employers
  • The value of employee to the employer
  • The growing importance of fringe benefits
  • Degree of skill and training to do a job
  • Nature of the work to be performed
  • Nature of the role and responsibilities required
  • Extent of unionization and its strength
  • The extent of authorization
  • Centralization of decision- marking
  • Need of geographical growth for the national growth.


The common types of compensation differentials could be classified as follows:-

  • Employee Based
  • Industry Based
  • Regional Based
  • Skill Based

Types of Compensation Differentials

  • Employee Based
  • Industry Based
  • Regional Based
  • Gender Based
  • Expertise Based
  • Work environment
  • Occupation Based
  • Experience Based
  • Size
  • Extent of Supervision
  • Technology
  • Nature of Product
  • Inter- Industry Based
  • Intra- Industry Based
  • Cost Of Living
  • Planned Economic Growth
  • Geographical Based
  • Employees Character Based

Wage and salary differentials exist at personal level too. Different persons having similar qualifications are offered different salaries in the same organisations. This happens because they have acquired different skills in spite of the fact that they may have similar educational background. This happens more so when skill-based pay system is adopted as against job based pay.

Employees character can be defined as job matching personality i.e., the type of occupation, level of skill and knowledge, working attitude and extent to which he/she can do the work independently. They can be classified as:

  • Occupational Wage Differentials
  • Skill Based Differentials
  • Gender based Differentials
  • Work behavior Based
  • Extent of Supervision/Experience Based

(a)Occupational Wage Differentials

Occupational differentials are based on skill, experience and training taken by the employees. These may be inter plant, inter industries and inter regional also. Inter plant differentials imply the differences in pay for the same or a similar job in the same industry, while inter industry differentials are for the same or similar jobs between industries in the same locations or in the same labour market at the same time. They are the pay differences for the same kind of input.

(b)Skill Based Wage Differentials

The wage difference among different degrees of skill of the workers appears in these differentials. Skilled workers on an average earn more than semi-skilled, unskilled and casual workers in any industry and in any state or country. Generally companies have found it necessary to widen the skill differences to attract the requisite skill-holders.

(c)Gender Based Differentials

Generally some of the jobs may need a masculine role and some may need a feminine role for its effective performance. These considerations employ women for some roles and only men for some roles, but because of the difference in the capacity to work the pay or wages differ accordingly, creating wage/salary differentiations.

(d)Work Behaviour Based Differentiation

The extent of efforts required to perform any task or work also vary, which necessitates W/S differentiation. Some may require manual work, some may require mixed efforts of machine and hand and some may require automation only to be supervised or monitored. Secondly, the complexity of work also makes differentiation in pay packages.

(e)Experience Based Differentiation

The entry-level wage or salary needs a rise when the employee gains experience in doing that job, develops expertise and can improve the quality and productivity. This rise may vary according to the level of excellence achieved level of excellence achieved level of degree of supervision needed, and the number of years of experience. Such differentiations are referred to as experience based differentiations or extent of supervision based differentiations.

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Industry based

Industrial and occupational differentials exist because of requirement of different skill set and imbalance in demand and supply of personnel having such skills. Wages and salaries are usually fixed on the basis of skills required to perform a job. Thus, highly specialised jobs requiring higher level of skills are linked with higher pay too. Coupled with this, shortage of supply of such personnel also induces the payment of higher pay. Presently, in India, various occupations based on the salary structure in descending order may be arranged as follows:

  1. Consultancy
  2. Financial services
  3. Investment banking
  4. Information technology
  5. Fast-moving consumer goods
  6. Advertising
  7. Pharmaceuticals
  8. Chemicals
  9. Consumer durables
  10. Electronics
  11. Electricals
  12. Automobiles
  13. Other engineering

Similarly, differences occur in terms of various specialities-management, information technology, Accounting, engineering and others in that order.

Organisational Differentials

Different organisations falling in the same industry group and at the same location offer different wages and salaries to individuals having similar background. The main reasons for organisational differentials are organisations policy to recruit specific types of personnel and their capacity to pay. For example, most of the multinational organisations operating in India offer much higher salaries to their employees as compared to their counterparts of Indian origin. Similarly, larger organisations offer much higher salaries as compared to smaller organisations.

Industry based differentiations refer to the wage or salary payment according to the nature of the job, types of industry, technical knowledge or expertise required, their paying capacity according to the size of the company and differential wages in similar industries or neighbouring industries. Accordingly, these can be classified as:

  • Nature of the organization
  • Size of the organization
  • Technology used
  • Inter Industry based differentials
  • Intra industry based differentials

(a)Nature of the organization

The pay packages may vary because of the nature of the organization, whether it is using a Hi-Tech process, manual process, automatic process, erecting or fabrication, repairing or machining shop, process industry, service industry, software or IT industry etc.

(b) Size of the organization

The Size of the organization determines its paying capacity, span of control, budget on human resources and competitive strength to determine the pay packages. This also decides differentiations.

(c) Technology used

The nature of technology being used in an organization may require different skills and knowledge or expertise which becomes the factor for determining the varying pay packages.

(d) Intra Industry (inter plant) based differentials

In the same plant or industry, the employer may pay different compensation packages, based on differences in the quality of work, quality of labour, imperfection in the market, and differences in efficiency of plant or machinery. Other factors, which reflect wage differences, could be (a) Technology advancement (b) Managerial efficiencies (c) financial capacity of the firm and (d) Age and size of the company.

(e) Inter industry based differentials

These differences arise when the workers in the same occupation and in the same area at the same time are paid different compensation packages in different industries in the same location.

Inter industries differentials generally arise due to the extent of unionization, their bargaining strengths, structure of the product market, the employer’s ability to pay and the stage of development of the industries paying a higher pay to expedite production. Other factors such as advancement in technology, managerial efficiency, financial strength and age of the company influence inter industry differentials.

Regional Differentials

Apart from industrial arid occupational differentials, there may be difference in wages and salaries region-wise also within the same industry and occupation group. Such differences are visible in different countries of the world as well as different regions within a country. Such differences exist because of the differences in cost of living pace of industrial development and lack of adequate mobility of personnel from one region to another. For example, wages and salaries are higher in metropolitan cities as compared to other cities; higher in cities as compared to rural areas.

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Implications of Wage/Salary Differentials

Wage/salary differentials have a number of implications both at macro and micro levels. At the macro level, these differentials determine the allocation of human resources and non-human resources. This allocation determines the growth pattern in the economic system. When a particular industry or occupation offers higher wages and salaries, the economic resources are geared to develop such personnel. For example, in India, educational activities have increased in the areas of management and information technology because these areas offer higher salaries and better job opportunities.

At the micro level, wage/salary differentials show that some organisations use proactive strategy to attract better talents as compared to others. They become trend-setters rather than play the role of followers. These trend-setters set pattern not only in relation to recruitment of better personnel but in terms of other human resource management practices too.


Q1.What do you understand by compensation differentiation? Why it is needed?

Q2. What are the factors considered for compensation differentiation? Discuss their significance.

Q3. Enumerate the difference between Intra industry differentiation and Inter industry differentiation.

Q4. What are basis of regional and occupational differentiation. Explain.


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