Wage Compression In Government Contractors Needs To Be Addressed

Wage Compression in Government Contractors Needs to be Addressed

Increasing the minimum wages paid by government contractors is complicated, as the government is beginning to learn.

Shortly after taking office the Biden Administration issued an executive order to require government contractors to pay their workers at least $15 an hour.

Besides the social justice reasons imposing a wage floor, the executive order explained that higher wages would also serve to improve the productivity of these workers. That is, by itself, true to some degree: There is considerable economist research showing that a higher wage that is above the market rate for a person’s skill not only attracts more capable and talented workers, but it also reduces turnover, which by itself improves productivity and efficiency.

While this wage increase may have boosted productivity for the workers who got a pay bump, the problem is that an increase in the minimum wage alone would result in wage compression, which creates labor market problems for a government contractor. If unaddressed, it could undo the positive benefits from boosting the minimum wage in this sector and reduce the quality of the critical public services provided by these companies.

Wage compression occurs when the difference in wages across people with differing skills and tenure within a firm shrinks or becomes nonexistent. In most companies, workers who are new to their job make less than someone of similar responsibilities with a greater tenure, and people who have been promoted or have moved into management make more than nonsupervisory workers.

In other words, a modicum of wage disparity across a company is not only necessary in most workplaces, but it’s something workers themselves expect–and take umbrage if it disappears.

I’ve seen this occur firsthand: When I was an economics professor, the dean of our college wanted to offer a newly minted PhD. of some renown a job with the math faculty at a starting salary that was above that of many of its tenured professors, who objected mightily.

The dean asked me (a labor economist who had friends in the department) to explain to them that because of the particulars of our compensation formula – designed precisely to mitigate wage compression – —their new colleague’s salary would result in every member of the department receiving a wage bump of at least a couple thousand dollars a year in the next two years.

No one cared: they took the high salary offered to someone junior to them as an insult and refused to offer him a position.

We are seeing this issue play out in real time across the nation. Long-time workers for government contractors that operate federal programs are demanding better wages and benefits in rural parts of America like Mississippi and Louisiana. Neither these workers nor the policymakers who support them realize that the hands of these employers are tied by a set of outdated regulations specified by the Service Contract Act (or SCA) that dictate how they compensate their workforce.

To truly reform how contractors compensate their workers, Congress must reform the SCA to address wage compression and help American taxpayers get better value for the essential services provided by contractors. We recently published a study that calls for Congress to address the problem of wage compression in government contractors. As it stands, the statute does not provide the guidelines necessary to meet the issue of wage compression, as well as today’s economic conditions.

In the study, we recommend that Congress not only codify the minimum wage set by the Executive Order but also obligate the Department of Labor to fulfill its roles as the authoritative agency on this issue. These include facilitating federal contractors to raise wages for non-entry level workers to avoid wage compression, as well as clarifying how wages should be set in the post-pandemic economy where most of their employees now work remotely, scattered across the country. Recognizing that these employees work on behalf of the government as a “blended federal workforce,” we also urge Congress to push the DOL to benchmark their health and welfare benefits to those provided to government employees.

Congress must consider these recommendations if they want to maintain a cost-effective system of federal contractors performing essential public services for Americans on behalf of the government. Otherwise, the status quo will continue to make these workers feel mistreated, leading to lower productivity and retention rates for essential public service roles.

While the answer to wage compression might seem to be simple – the government contractors boosting the wages of all its workers under the SCA – such a task is not so easy to accomplish. Contractors negotiate compensation structures in their multi-year contracts, which set fixed profits for these firms. While the government increased its payment to contractors to account for the higher minimum wage, it has no obligation to pay them more to account for higher wages for other employees. The current version of the SCA says, in effect, that these companies cannot address the issue of wage compression without upsetting these agreements – unless they want to significantly diminish their profits.

Workers hired by government contractors do a lot of important work for Americans, and it is in everyone’s best interest that they are paid fairly and that the government gets the most from the taxpayer dollars it spends on their services. Addressing wage compression and related issues by reforming the SCA would benefit everyone.

Chad Cotti, professor of economics at the University of Wisconsin Oshkosh, co-authored this article.