Doing Away with the Principle of Seniority May Cost Jobs

High loyalty bonuses for longstanding employees of German companies are a considerable obstacle to employment for more mature job-seekers. Representative studies conducted by the Centre for European Economic Research (ZEW) show that the share of older new employees on all new employees is ten percent lower in companies who pay a three per cent loyalty bonus than in companies with only two per cent loyalty bonus. Furthermore, German companies pay higher loyalty bonuses than their international counterparts, and more mature job-seekers find it more difficult to re-enter the labour market in Germany than in most developed economies.

It would be problematic, however, to call for an abolition of the so-called seniority wages, i.e. bonuses paid to employees for their staying with a company, on these grounds, as EU Commissioner for Employment, Social Affairs and Inclusion, Vladimir Spidla, has done. “Because what sounds like a plausible plan to re-integrate more mature people in the labour market may result in job losses for employees in general", explains Prof. Dr. Thomas Zwick, research associate in the ZEW department for Labour Markets, Human Resources and Social Policy.

Zwick, who intensively studies seniority wages, points out that without the principle of seniority, companies may be forced to create new, more expensive incentive systems. So far employers choose to pay out loyalty bonuses, which comprise an automatic raise in pay the longer a person is employed in one company, because they are an efficient measure to bind experienced employees with valuable know-how to the company and to motivate them. In a study completed recently (ZEW Discussion Paper No. 08-039), Zwick proves seniority wages’ power to bind employees to one company. For instance, if a company rewards a person’s employment with this company with a salary increase of annually three per cent, employees stay with this company around six years longer than employees of companies offering the usual two per cent salary increase. If seniority wages were to go amiss as a measure to keep employees, companies would have to find new ways to bind valuable staff. “A performance-bound wage increase would be possible. However, given that this measure would apply to all employees, it could be costly for the company”,says Zwick.

But companies’ average wage levels could also rise as a result of the elimination of loyalty bonuses. While older employees would be less costly for firms, younger employees would be more expensive – companies with a high loyalty bonus currently pay lower starting salaries than companies with an average loyalty bonus. Since younger employees can no longer expect unproportional pay raises, it is highly probable that they choose to work for a different employer if this change entails a wage increase. A high starting salary could prevent this. “However, the companies’ overall labour costs would increase. This could potentially result in job-cutting measures and thus the dismissal of employees – regardless of the employees’ age”, Zwick warns.

For further information please contact

Prof. Dr. Thomas Zwick, E-mail: zwick@zew.de