Wage Interactions: Comparisons or Fall-back Options?

It is widely accepted that wage comparisons with other firms play an important part in wage bargaining, but what is less clear is precisely why these comparisons are important. There are two main explanations. First, that fairness considerations mean workers are unwilling to see their wage fall below that offered in other similar firms. Second, that wages in other firms constitute a worker's fall-back option since if the worker leaves his current firm he will probably seek employment in the same industry. Unfortunately, it is difficult to distinguish between these two explanations since both offer similar predictions. This paper proposes that these two explanations can be differentiated by looking at the role of 'pay leaders' (firms that set the standard for later settlements and which, anecdotal evidence suggests, dominate changes in pay and conditions in an industry) in wage bargaining. If the fall back option is important then the pay leader should only influence wages in other firms to the extent that the pay leader firm constitutes one of many firms that workers could move to. If, on the other hand, fairness is important then the pay leader can have a disproportionate influence by creating the standard for other wage negotiations. Using a unique panel of data covering 321 bargaining units in the UK chemical industry between 1978 and 1989, the paper then looks at the influence of the pay leader in that industry (ICI) on wage setting in other firms. It finds that the ICI wage does indeed have a disproportion effect on wage bargains in other firms; indeed ICI's wage dominates all other measures that capture the worker's fall-back option. This supports the notion that it is fairness considerations that drive wage interactions.