Recently, there have been many discussions on restructuring the traditional seniority-based pay structure into a job-based pay structure. The pay structure is the system for base pay, which can broadly be divided into seniority-based pay structure, which determines the salary according to one's years of service, and job-based pay structure, which determines the salary by the value of the job position. Many people argue that the seniority-based pay structure should be restructured into the job-based pay structure because the degree to which wages increase with seniority (seniority-based pay) is excessively high in Korea. Accordingly, the government set the restructuring of the pay structure as one of the two major goals for labor market reform in 2022 and is in the process of restructuring the pay structure to a job-based structure by launching the "Win-Win Wage Committee," which consists of experts and high-ranking government officials, in 2023.

1. How high is the seniority-based pay in Korea?

According to the data provided by the "Win-Win Wage Committee," workers who have worked for 30 years or longer in Korea earn 2.87 times more than new employees, which is 2.27 times higher than Japan and 1.67 times higher than the EU. Those calling for pay structure reform use this international comparison as evidence of the high seniority-based pay in Korea. However, a simple comparison of seniority-based pay between Korea and other countries may not be appropriate, considering that it is affected by various systemic factors.

Let us examine the following figures to gain a better understanding of the concept.
(Figure 1) Relationship between Productivity and Wage in the Seniority-based Pay Structure
(Figure 2) Comparison of Seniority-based Pay in Korea and Japan

(Figure 1) shows the relationship between productivity and wage in the seniority-based pay structure. In this structure, the wage increases linearly with the tenure, but productivity changes in the form of the S curve of learning. Therefore, in the seniority-based pay structure, the productivity and wages do not match at each point in time. However, because productivity and wages should be in balance for an organization to acquire and maintain the necessary personnel, the seniority-based pay structure retains the balance between productivity and wage by terminating the employment contract (retirement) when the net productivity of a worker is equal to the total wage (b=a+c).

(Figure 2) compares Korea and Japan to show how seniority-based pay changed in each country depending on the point of retirement. While the legal retirement age in Korea is currently 60, Japan mandates that workers remain employed beyond the age of 60 until the age of 65. The graph above shows that if workers work in one organization for a long time, as in the case of Japan, the seniority-based pay should be lower than the current rate in Korea if all other conditions remain the same.

If it is difficult to determine the appropriateness of seniority-based pay in Korea by comparing it with other countries, since the labor markets display different characteristics, such as the different retirement ages, what can be used as criteria for evaluation? While various socioeconomic factors should be considered comprehensively to determine the appropriateness of seniority-based pay, the most important and direct criterion would be its effect on organizational performance.

2. How does seniority-based pay affect organizational performance?

There are conflicting arguments concerning the impact of seniority-based pay. Seniority-based pay can positively affect organizational performance by deferring a portion of the wages to the future, thereby accelerating the accumulation of company-specific human resources and efficiently resolving the agency problem. However, high seniority-based pay may harm organizational performance as more tenured workers may receive wages that exceed their productivity, resulting in higher labor costs and making it more difficult for companies to reward good performance.

Such contradictory arguments can only be resolved through empirical research, but unfortunately, research on the topic is lacking. However, according to a recent study, higher seniority-based pay is associated with higher organizational performance, except in cases of extreme technological change, suggesting that the argument that the seniority-based pay is too high in Korea might not be well supported.

3. How can seniority-based pay be lowered?

That being said, what can be done if seniority-based pay has to be lowered? Proponents of pay system reform expect the introduction of a job-based pay system to alleviate the seniority in wages in Korea. However, according to existing research, the effect of the job-based system on seniority-based pay is minimal. First, this is because seniority in wages is not only affected by the pay system but also by various factors, such as promotion. According to one study, more than half of seniority in wages in Korea is driven by tenure-based promotions. Second, contrary to the general perception of the job-based pay system, tenure is either officially or non-officially factored into the job-based pay system. For instance, even in the merit pay system, which is widely used in Western countries to determine wages based on performance evaluations, wages tend to increase naturally with tenure because the wage increases are accumulated each year.

A more effective way to lower seniority-based pay is to create a more flexible labor market. The seniority-based pay system, which involves backloading a portion of wages into the future, can only function fully if most workers work until retirement age to receive their deferred wages. In other words, the seniority-based pay system presupposes an agreement between labor and management on lifetime employment. As a result, the weakening tradition of lifetime employment and flexibility in the labor market inevitably leads to lower seniority in wages. Perhaps this phenomenon is already taking place, considering that young workers do not expect themselves to stay with an organization for life.