Transferring the Cost of Wage Rigidity to Subcontracting Firms: The Case of Korea
We select a Korean case with ample subcontracting practices and a rigid wage system. Workplaces with subcontract transactions would have reason to impute the additional wage incremental costs associated with the seniority-based wage system (Hobong in Korea) to subcontractors. Our empirical results identify the cost-transferring mechanism under which the cost of wage rigidity for contractors is transferred to subcontracting firms and aggravates the wage inequality among workers in contracting
... subcontracting firms. We analyze the industrial difference in the intensity of this transferring mechanism and probe policy directions considering the improvement of both the subcontracting structure and pay system simultaneously. For the sustainability of firms, they need to reform a seniority-based wage system, an incentive-based wage system or a job-based wage system and the exploited subcontracting structure for creating share value. Sustainability 2016, 8, 845 2 of 15 suggested by Imrie  . The dualistic theory could be applied to the situation where the size of a subcontractor is small, the bargaining power for most of the subcontractors is lower than that of the main contractors and the subcontractor should follow the specific conditions and orders from main contractors. Under this condition, the main contractors are more likely to secure their labor flexibility and shift the additional costs to subcontractors, and subcontractors would be forced to passively deliver according to the terms required by the main contractors    . A workplace using the seniority-based wage system would incur the additional wage increment by seniority, which would be incurred regardless of performance, as well as costs associated with securing labor flexibility and investment in production [5-7]. Therefore, the profit level of the workplace with that wage system would be decreased due to the additional wage increment, even though its profits would be similar to other firms. It can be judged that the workplace having a seniority-based wage system would be motivated to make an effort to improve efficiency through finding a way to implement either the seniority-based wage system along with the job-based wage system or the competence-based wage system. However, workplaces with subcontract transactions would have cause to impute the additional wage incremental costs associated with the seniority-based wage system to subcontractors rather than to improve the wage system, which would incur complicated issues. If contractors can attribute these costs to subcontractors through the requests of price reduction, they would minimize the burden of wage increases and conflicts with their employees and increase their wage level. Due to these causes, the incentives of main contractors to improve their wage system would be gradually diminished, and the financial difficulties of subcontractors would be enlarged as a result of the price reduction. Worse than this, it may be expected that the wage gap between main contractors and subcontractors would be intensified, the quality of product to be delivered to the main contractors would be deteriorated and the financial difficulties of small and medium-sized companies would be exacerbated. By analyzing subcontract structures and pay systems, as well as the interaction between them, the main purpose of this study will be to evaluate the very existence of their relationship. This paper attempts to empirically explore how subcontract structures and pay types bring about the wage gap among firms by analyzing the interaction between the subcontract stage, such as main contractor-first level subcontractor-second level subcontractor and pay types, such as the seniority-based wage system, the job-based wage system and the competence-based wage system. It also tries to quantitatively estimate the degree to which these links cause the wage gap by analyzing these relationships by industry. This information could help the basis to make the policy of improving the wage gap tailoring to the characteristics of industry by empirically analyzing the relationships by industry. This paper proceeds as follows. Section 2 investigates previous literature and the current states in Korea regarding subcontract structures and wage systems. Section 3 examines the model for the empirical analysis and basic statistics of the data for this study. Section 4 investigates subcontract structures, wage systems, as well as the interaction of them on the pay level by empirically analyzing the various models specified in Section 3. Lastly, Section 5 provides conclusions and policy implications. Previous Literature According to previous studies, subcontracts can be divided into three types. The first is the dualistic theory. The dualistic theory is based on the assumption that the main contractor and the subcontractor do not have equal status. Characteristics of this theory include (1) the size of subcontractors is small; (2) most subcontractors have weaker bargaining power than the main contractor in subcontract transactions and (3) subcontractors are forced to follow the specific conditions and orders of the main contractor. Under these conditions, main contractors are more likely to ascribe additional costs related to labor flexibility and production investment to subcontractors and force subcontractors to passively deliver to the main contractors through requested conditions  . Besides, under the dualistic theory, this relationship is not improved as time goes by and, thus, produces a vicious circle. This dualistic theory has persuasive power in most Korean subcontract relationships.