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Personnel economics is the application of economic principles,
statistics, economic theory, mathematics,
even, to questions that were traditional human resource questions.
So questions that people would not normally think of as lending themselves
easily to economics, motivating workers,
hierarchical kinds of questions, how much authority should you give to your workers?
Those issues that were traditional in human resources were dealt with in
quite a different way.
So if you think about organizational behavior, which is another field in our
business school and in most business schools, they think of it more from
the psychology point of view or sometimes sociology point of view.
Whereas I deal with it, and to be honest, I would say a harder-nosed way,
more mathematical, more statistical way.
And that's what personnel economics is about.
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If you look across countries, and you say, in which countries have
workers enjoyed the highest wage gains, say, over the past 15 years?
And then you say,
in which countries have workers been most productive in the past 15 years,
what you'll find is that the correlation between those two is very, very strong.
What that means is that if you go across countries and you look at these countries
that are being effective in raising worker productivity, are also the ones
where workers are seeing their wages grow, so that's really important.
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One of the most traditional ways to motivate workers and
to increase both their productivity and their earnings,
is to pay them something that's called a peace rate.
Most of us are familiar with peace rates.
There are a couple of obvious examples.
Uber is a peace rate, why is Uber a peace rate?
Well, because you basically get paid for the number of rides that you give.
Depends on the amount of time that you spend driving, but
more than that it depends on the actual amount of miles that you drive.
And so they're paying you on the basis of your output,
that's a very effective way to motivate people.
And of course, if you look at Uber drivers, they're pretty darn motivated.
They work pretty hard, they work long hours.
They are very good at figuring out the system, how best to get rides,
where to locate at certain points in time.
What does that for them, the fact that they are directly paid on
the basis of their output, so that's a great motivator.
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How do you motivate people in situations where output is difficult to measure?
Most of those kinds of jobs are managerial jobs,
and managerial jobs are important for the economy,
because they are the basis of much of our productivity.
It's not just the workers, it's the people who are managing the workers,
supervising them, teaching them, guiding them.
How do you motivate the teachers and the motivators?
Essentially what you have to do is,
you have to pay on the basis of relative performance.
So something that i came up with a long time ago, again, in my youth,
it's called tournament theory.
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What tournament theory is about is, it's kind of obvious when you think about it,
it's not very complicated, you kind of wonder why no one thought about it before.
But it's basically the idea that firms structure their compensation
in the same way that people run tournaments, sports tournaments.
So for example, if you think about Wimbledon, tennis match, and
you say, how does Wimbledon work?
Well, Wimbledon works by paying a prize to the winner, and second place prize
to the loser of the finals, because that's the second place person in the tournament.
The difference between the winner's prize and
the losers prize serves to motivate those players.
Now they would be motivated even if they didn't have that prize, but
depending on the size of that prize, they'll be motivated even more.
So for example, if there were a million pounds at stake winning that tournament,
people would be highly motivated to play.
And that's what happens in business.
So what tournament theory talks about is, first of all,
how to set up those implicit contests, competition between these workers, do it
in a way that doesn't undermine the firm, because sometimes competition can be bad.
They'll work to sabotage one another essentially,
because they're trying to get the next promotion.
And then finally to think about how big a raise should you give those individuals
when they get promoted from one level to another to both motivate them below and
then give them incentives above?
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Another way that workers are sometimes compensated is on the basis of the team,
why would you do that?
Well, sometimes people need to cooperate, and in order to get them to cooperate,
you have to pay them on the basis of their joint output,
not on the basis of their individual output.
Let me give you an example.
There's a good example by one of my colleagues here, Catherine Shah,
who with a couple of co-authors did a very nice study of a firm in Brazil
that was actually a law firm.
And what they did was, they had initially paid their lawyers on the basis of their
billings, straight on the on the number of billings, that's a measure of output.
Sounds great, because you can easily observe it, you basically know who's doing
what, you can motivate them very effectively, but here's the problem.
Because they were being paid on the basis of their own billings, the senior lawyers,
who had the ability to allocate cases to one another,
took all the great cases for themselves,
even when they weren't necessarily the best partner to handle the job.
And so what the firm did is, they said, our junior people, some of whom
are highly qualified to be working on these cases, are not getting the work,
because the senior guys are taking it all for themselves.
What do we do?
We've gotta change the compensation structure so that you're paid not only on
your own billings, but you're essentially paid on the profitability of the firm.
Now, because you're paid on the profitability of the whole firm or
of a sector of the firm, you care not only about how well you do, but
you also care about how well your coworkers do.
As a result, there was an enormous transformation in the way that work was
allocated, and an enormous transformation as well in the productivity of the firm.
So profits went up, billings actually went up, and
the work was better handled and people were much happier as a result of that.
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Team compensation can be very effective.
One problem with team compensation is it doesn't always work, why not?
There's something in economics called the free rider problem,
I'm sure many of your listeners have heard about that.
But the free rider problem comes about when you have an incentive to shirk and
basically put the burden on someone else.
Some of your viewers may remember when they were in school,
perhaps even at Stanford Business School, although we don't have any shirkers here.
But if you're involved in a team project,
suppose five of you have a homework assignment,
you have to get together and write up the assignment for the whole team.
Sometimes one person will work harder than another person, and
sometimes even a teammate might be critical of the other teammate,
because of the behavior of the other teammate,
not putting in the appropriate amount of effort, the appropriate amount of time.
So the free rider effect comes about in teams, and as the team size gets larger,
the free rider effect becomes more pronounced.
Because your ability to affect the total output of the team gets smaller and
smaller.
So team output, team compensation can be affected
in a strong way as long as the teams are structured appropriately.
First of all, you have to make sure that the teams Involve
people who are highly complimentary to one another.
So you want to make sure that I'm working with someone whose
output will benefit greatly from my input and vice versa.
You also want to make sure that the team is small enough so
that we can observe each other, we can monitor each other,
we can motivate each other, and that's an important component as well.
So firms can use team compensation, but
they have to be pretty careful about the way they set it up.
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People often work for a long time in a company, and the question is, what do
you do to motivate managers when they're essentially done with a tournament?
What do I mean by done with the tournament?
Look at me, I've been the equivalent of a middle level manager for most of my life.
I'm a senior professor at Stanford, but there's nowhere for me to go.
I have no aspirations to be a dean or anything like that.
So how do you keep me motivated?
Well, again, there are ways that you can do this that have to do with compensation
in addition to non-monetary forms, but let me give you the one that's compensation.
So when I was a young guy, and I was working really hard trying to get tenure,
at this point it was at the University of Chicago.
And I was looking at my senior colleagues, and while they were very smart and
very productive people, I still thought that I was working a lot harder and
even more productive.
I wrote a lot of papers in those days, I still try to write a lot of papers.
But when I was a young person, I was probably better at it than I am now.
And yet I was paid a lot less than my senior colleagues, and I thought,
why is that, isn't this kind of crazy?
I'm the guy doing all the work, and they're the guys making all the money.
And so I thought about it and I realized, well, actually,
that motivates me, because what happens is, as a result of
seeing my senior colleagues make a lot of money, I want to be a senior colleague.
And that was true throughout most of my career.
So when I was in my 30s and 40s,
at that point I was already a tenured professor with an endowed chair,
there was pretty much nowhere for me to go in the tournament, but
I still cared a lot about being successful in the organization.
Not only because I wanted Stanford to succeed and I wanted myself to succeed,
but also because I wanted to be well treated in my old age,
which I have now reached.
And I am well treated, and I think part of that is because I try to continue
to be productive, but part of that is also pay off for what I did as a younger man.
And that motivates the younger generation, it motivates the 40 and 50 year olds, many
of whom are still very productive, and we want to keep those people very productive.
By their ability to see how Stanford treats me, they say, all right,
if I perform well, I understand that someday I'll be like Lazear,
and maybe I'll be a little bit overpaid, but it's okay,
it's compensation for what I'm doing right now.
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