On Overtime and Penalty Rates

Periodically, the issue of overtime and penalty rates returns to the economic agenda, the thesis of the right wing of politics being that they are an impediment to employment.

Of course they are. Any commercial employer would need to think carefully about their expected return before paying someone 2½ times normal wages for an 8 hour public holiday shift. Government services such as hospitals and police have less of a choice, so the extra wages are factored into budgets, although they often run a skeleton staff on nights and weekends.

The counter argument is that the majority of activities in Western society are structured around a weekly schedule, with work during the day from Monday to Friday, weekends for sport and leisure and night times for family and entertainment. Thus, people who work outside the normal hours need extra compensation for missing out on potential social and family time, or a share of the extra profit they have helped bring in. Quite reasonable if that extra compensation is not so onerous that it removes the motivation of the employer.

So, what’s the correct balance and how can it be achieved?

John Alexander, Federal MP for Bennelong has proposed that penalty rates be abolished as a guaranteed award entitlement, wholly negotiable between employers and employees on an individual basis.

ACTU president, Ged Kearney made the predictable union response, which is essentially my argument above, albeit with politically pious misrepresentations of her opposition, such as “few people outside the Liberal Party want to live in a nation where we treat with contempt the people who serve us our Saturday morning coffee”.

John Alexander deserves credit for consigning that too pleased with herself fraud, Maxine McKew to the political dustbin. However, his proposal misses a key point about wage negotiation: the power relationship between employers and employees is not symmetrical.

Overtime and penalty rates may already be negotiated to a significant extent as part of Individual Flexibility Arrangements (IFA) under the Fair Work Act 2009, so I suspect what John Alexander is really on about is completely removing from awards formulae such as double time and a half for public holidays. The effect would be to remove an anchor point for negotiations when conditions are being traded for increased hourly rates, thus establishing a completely free market for work outside standard hours, with rates of pay for identical hours and tasks varying by business and even individual employee.

This all looks great to the type of economist who begins by assuming symmetries such as employers and employees having access to all information relevant to their economic decisions, or no employer being large enough to materially perturb the market. These conditions aren’t satisfied by the real market: employers know more relevant information than employees (such as what their entire workforce gets paid) and there is an unequal power relationship, almost always in favour of the employer. Consequently, none of the conclusions regarding the establishment of market equilibria apply in reality.

Economists like this remind me of the joke about the physicists who derive from first principles the optimal milking machine. When asked how it works, one begins the explanation: "Consider a spherical cow …"

In the same SMH article as Ged Kearney’s comments, an academic apparently of the above variety, Mark Wooden makes a facile version of the free market is best argument. He does not explicitly say the market would reach and eventually fluctuate about an equilibrium, but he implies it.

Looking at Mark Wooden’s CV, he’s made a very successful career out of constructing simple, linear models of various economic interactions and using undergraduate statistical techniques to fit them to survey data and test a set of hypotheses, the tests being dependent on his choice of model. All pretty easy stuff if you can do maths. Even easier when you have honours and PhD students to do the number crunching. I’ll bet he’s very good at networking.

Lots of academic papers does not imply a genuine understanding of the real economy.

The point I want to make is that macroeconomic processes are more like evolution than like the thermodynamic equilibrium style systems favoured by many economists.

Suppose many individuals trade away their overtime and penalty rates, allowances and leave loadings for higher, but more uniform hourly rates. In the absence of award rates, the values of the net trade offs will be correlated, with the correlation provided by the information available to employers, but not the employees. Without anchors such as award prescribed overtime and penalty rates to allow each employee to determine the value of what they are trading away, this information asymmetry is more likely to have the effect of driving down overall employee compensation. Eventually, we are likely to reach a point in most industries where the norm is that work outside of standard hours does not pay much more than working standard hours, due to the cumulative effect of some employees being willing to accept less than others for the same work and employers being able to bargain with more knowledge than employees regarding what wage offers the potential employees will except.

If the economy is represented as consisting of small employers, as it is in many equilibrium economic models, the information asymmetry above is small. However the real economy contains sufficiently many large employers, whose bargaining power is an order of magnitude greater than their employees. This is what causes the asymmetry.

Effectively, the value of society’s temporal structure: evenings for family, weekends for sport and leisure will have been eroded by the cumulative, correlated effects of the lowest common denominator. The lumpenproletariat will always lose to the more powerful and better informed via this process, but in this case, so will we all.

That’s why we need to keep some level of mandated overtime and penalty rates. It’s not so much to save the ignorant and powerless from themselves, but because the consequences of their cumulative decisions in this case will be as important as the erosion of the meaning of the weekend.

Firstly, let’s define clearly which employees we’re talking about: people who aren’t in senior management or very specific, technical roles ie. most working people. Senior management have always negotiated their compensation with their employers on an individual basis, as have specialized programmers, financial market traders etc. They don’t receive overtime or penalty rates.

Even in a very strong economy with very low unemployment rates, ordinary private sector employees can’t demand whatever pay and conditions they like; even small business employers will simply wait for another applicant.

Public sector employees cannot negotiate wages and conditions with their employer on a fair basis: they have the entire government bureaucracy against them.

When the economic pendulum swings, there is nothing other than the industrial awards system to prevent employers offering very low wages, with no penalty rates.

Suppose we did free up overtime, penalty rates, sick leave etc. and allowed them to be negotiated away on an individual basis. If one or several employees agree to trade away certain conditions, such as penalty rates or sick leave, there is nothing practical to prevent employers pressuring the remaining employees to do the same, even if those employees have said conditions written into their own contracts.

It is all very well for a government to say that there will be safeguards such as making it illegal for employers to demand renegotiation of employment contracts.

But there are ways and means. Small businesses simply give casual staff on the old contracts progressively less shifts, citing falling profits. They make permanent staff redundant, unless they have been working there so long it is not worth it. It’s possible for affected staff to bring a case before the Fair Work Ombudsman, but any business with a decent accountant and legal advice should be able to gradually engineer such changes to its workforce with impunity.

Large businesses find the process even easier due to natural staff attrition. Very few redundancies are required, unless they are in a real hurry. Just offer only the new contracts to all new employees. Don’t negotiate unless the employee is one in a hundred: someone else good enough will come along and take the job under the conditions you’re offering.

Public sector employers are in an even stronger position relative to the employee. The management culture of bureaucratic blame avoidance in these organizations will allow managers to follow the new hiring directives, even to the obvious detriment of the organization as a whole.

But the real issue is not what occurs within any one employer: it is what happens across an entire industry or across the entire economy.

Gradually, more and more people trade their entitlements and conditions away for higher hourly wages. Each recession, these wages are cut in real terms. There is nothing to stop this as collective bargaining disappears and legislation setting out core entitlements is amended. Over time, perhaps a generation, the new conditions become the norm and the balance of power has swung too far toward employers, who see nothing wrong with “asking” employees to work on Saturdays instead of playing sport or being with their family.

Those opposing this argument often try to represent employers as small business people such as a café or shop owner or a tradie.

Of course, many of them are. In such cases, there is room for flexibility (within reason), since the employees’ wages are coming directly out of the owner’s pocket. “I need to open this Easter Friday, but I can’t pay you $50 per hour. It’s not worth it to me, so we’ll both lose. I’ll give you $35.” That can work, because it’s a private arrangement and the wage price information doesn’t spread widely and rapidly.

When such flexibility doesn’t work is where the employer is represented by some middle level manager with no material financial stake in the business, but is trying to impress (or is following the instructions of) someone higher up. The point is that it doesn’t take much hierarchy within an organization for significant diffusion of responsibility to develop and for managers to start acting like dickheads: refusing to admit they are wrong, licking arses, pursuing personal vendettas etc. It’s the employees who will suffer and with such a powerful lever as flexible wages and conditions to pull, suffer they will.

If society wants to keep temporal structures which are a fundamental component of its organization, such as weekdays being for work and nights and weekends for rest and leisure, it needs to keep some base level rules about pay and conditions which can’t be traded away independently by many individuals, gradually leading to the erosion of these structures.

Penalty rates needs to be at sufficiently attractive levels to compensate workers, particularly for 24/7 employers such as hospitals and police.

So, how much are the overtime and penalty rates we’re talking about? Are they consistent? Are there fairly evident base levels, with some other provisions which can be traded away without detriment to society as a whole?

I’ve picked four industries which by are significantly affected by any changes and reflect a cross section of employers: retail, hospitality, restaurants and health. The figures I’ll quote are for full time employees.

Casuals generally receive an extra 25%. Why?

Because permanent employees receive paid holiday, long service, sickness and carers’ leave. That’s 9 public holidays, 20 annual leave days and up to 15 days of personal / carers’ leave, plus an 11% long service leave accrual, all paid. It means permanent employees receive a given annual salary in return for working 43 weeks per year. Thus, casuals, who are only paid for any hours they work, should receive an extra 9/43 = 21% on all shifts just to be equal.

But casuals get a flat 25% loading on all shifts. That is, 150% pay on Saturdays instead of 125% = an effective 20% extra. Sunday work is 225% pay instead of 200% = 12.5% extra. To receive 21% extra for Sunday work, casual workers would need a 42% Sunday loading. Additionally, given that casuals often work shorter shifts, the proportion of time and money spent traveling to and from work is greater.

In light of this, the flat 25% casual loading is pretty accurate compensation for the loss of paid leave.

I’ve included a fair bit of information so we can see which provisions seem to be standard across all industries and which vary significantly.

The General Retail Industry Award 2010 allows a 25% loading for Saturday or evening work (after 6pm). After 6pm on Saturday gets 50%. Sundays get double pay and public holidays get 2.5 times normal pay. Overtime receives a 50% loading for the first 3 hours, then 100% after that. Note that the overtime rates already incorporate the loading for after hours work, so that if you do overtime from 6 – 9pm, you get an extra 50%, not an extra 50 + 25%.

Base wages are from $17 to $21 per hour depending on job level.

Employees can negotiate time off in lieu, which must be pro rata. That is, if someone works a full Sunday, they can take two weekdays off in lieu.

The Restaurant Industry Award 2010 has almost the same penalty rates as for retail employees, except Sundays only get a 50% loading instead of 100%. Monday to Friday, it allows a 50% loading for the first two hours of overtime and 100% for any extra hours beyond this. There are additional 10 – 15% loadings for working between 10pm and 7am. Base wages are from $15.50 to $20 per hour depending on job level.

As one might expect, the Hospitality Industry Award 2010 has identical base pay scales and almost identical overtime and penalty rates to the restaurant industry. The only differences are that the 10 – 15% shift work loading begins at 7pm instead of 10pm and the Sunday loading is 75% instead of 50%.

The Health Professions Award 2010 covers doctors, nurses and support staff, so of course pay scales vary greatly. Day work on either Saturdays or Sundays receives a 50% loading and public holidays receive what seems to be the standard 150% loading. The award allows what seems to be the standard overtime loadings of 50% for the first two hours and 100% for any extra hours beyond this. Any overtime on Sundays is a 100% loading from the first hour. Shift work begins at 6pm and receives a 15% loading.

The first thing that struck me is the small allowance for shift work compared to overtime. Shift work usually gets an extra 10 - 15% (25% for retail) and overtime gets up to 100%. Overtime is basically shift work after you have already worked, so it should receive more than ordinary shift work, but the discrepancy in rates seems excessive.

An extra 10 – 15% doesn’t seem enough for working nights, given the documented adverse health consequences, many of which seem to stem from sleep problems due to a disruption of circadian rhythms. An Australian Bureau of Statistics 2009 survey says that approximately 15% of Australian workers do shift work, so a significant proportion of the population is potentially affected.

Perhaps the onerous overtime provisions are intended to act as a deterrent to employers regularly asking employees to stay back. If there’s a regular need for someone to work those hours, they should employ another person, presumably on a casual basis.

Suppose for example a hotel wanted someone on reception from 7 – 11pm. Overtime would cost them an average 75% loading, whereas a casual shift would cost them 35% (plus the administrative costs of the extra employee).

The punitive extra 40% cost of 4 hours regular overtime versus an extra casual would thus tend to result in the employment of more people.

The real question here is: how much overtime is sought by employees? Another ABS survey found that approximately 25% of employees in the accommodation and food services industries would prefer to work more hours. This doesn’t mean all of those 25% want more overtime, but we know that at least three quarters don’t.

If many employees want overtime, it’s probably because of the high pay rates. But this is exactly the situation where employers should be allowed to reduce the loading.

Clearly there is a need for some measures to prevent employers abusing the system and pressuring employees into overtime. In theory, these already exist in the awards as proscriptions against unreasonable demands, but it’s really only permanent employees who can refuse without fear of punitive action through reduced shifts.

So, there needs to be an overtime loading for the 2+ or 3+ hours rate which is significantly more than the 15% shift plus 25% casual allowance. But 100% instead of 40%? You could probably cut this to 50% and standardize the time at which it cuts in at 3 hours, then let people trade away any award amount above this for higher hourly rates of pay.

I can’t see how employers could complain about Saturday wages. An extra 25% is a problem? Anyone saying that shouldn’t be in business. $4 or $5 per hour ie. $30 – 40 per shift for missing out on playing sport doesn’t seem unfairly balanced in favour of the employee. An extra $4 or $5 per hour for working after 6pm? Considering the employer is probably making a considerable profit if they choose to be open on a Saturday night, paying an extra $8 – 10 per hour over the weekday rates seems pretty reasonable to me, considering your employee is working while everyone around them is enjoying themselves.

The Sunday and public holiday rates could probably be re-examined. Why do you get a 50% Sunday loading working in a hospital or a restaurant, 75% in a hotel and 100% in a shop? That’s just stupid.

Make it 50% flat as the non-negotiable component and let people negotiate away the rest if they want to.

We need a big loading for public holidays to encourage people to work, since this will mostly apply to services which must stay open: hospitals, police, the fire brigade, hotels, service stations. But is a 150% loading too much as a non-negotiable base?

I think so. Christmas, Easter and New Year’s Day are more than an average Sunday, but does that necessarily mean you aren’t allowed to negotiate down to a 50% loading? Maybe, since a large proportion of such wages are paid by the government and we don’t want the gradual erosion of the incentive to work such days by the action of many individuals trading away the loading.

What does trading away above base award conditions mean in practice?

In a given industry, say nursing or police, there are a known number of nights, Saturdays, Sundays and public holidays which must be worked. The proportion of total working hours in each category and thus the total number of yearly base equivalent hours per employee is easily calculated.

It is therefore simple for the government to provide an online calculator for each industry award which stores base rates of pay and current award loadings. It would allow the proposed new loadings to be entered (rejecting ones which were too low) and the new, hourly rate of pay returned. Very simple and a useful tool for both employers and employees.

This means each award would need to have its own standards, as well as there being universal base levels.

One might well ask why the Fair Work Ombudsman doesn’t already provide such a calculator, given that some trading can already occur under IFAs. It provides a document of guidelines on preparation and use of IFAs, however in typical public service fashion, the document makes no mention of the information employers and employees most want: If I trade away this, what should I get paid now?

No wonder many employers are unwilling to try to implement variations to the award. Some decisions by Fair Work Australia overturning what appear to be legitimate interpretations of the IFA rules don’t help much either.

Any differences between award and general base level overtime and penalty rates will probably slowly evaporate as a significant number of individual employees choose to negotiate away some penalty rates in favour of higher hourly base pay rates and are then preferred for employment. Industry commissions will tend to reflect the new norms in their future revisions of award conditions, for example by responding more positively to requests to increase hourly rates and lower Sunday loadings for example.

This would have the negative effect of decreasing the distinction between weekend and weekdays, but also remove some of the impediments to casual employment on Sundays and public holidays which get free marketers excited.

We don't need to go as far as the Liberals’ former Work Choices policy, however we can also be more flexible than legislating double time and a half. If reasonable general loadings are maintained by legislation eg. 50% overtime, 25% casual, 25% Saturday, 50% Sunday, 75 - 100% public holiday, society still maintains its necessary distinction between days & nights, weekdays & weekends and public holidays by valuing work at such times disproportionately.

At the same time employers are freed up to say: “I want to open on Sunday. I’m offering $27 per hour instead of $34, but you’ll get $18 an hour during the week instead of $17”. People should be able to make their own decisions about such offers without society being destroyed.