Saturday, September 04, 2010

Why does paid vacation exist?

Amidst the discussion by Ezra Klein, Matthew Yglesias, and Reihan Salam about paid vacation, I think it's useful to ask a more fundamental question: in countries like the United States that don't require it, why does paid vacation even exist?

This is not a trivial question. Employers could simply offer an equivalent amount of unpaid leave, providing an option to employees who prefer to take time off while rewarding workaholics for continuing to contribute value to the company. Why doesn't this happen? As far as I can tell, there are four plausible stories:
  1. Per-hour productivity declines when stressed employees don't take any vacations. In an ideal world, this might be written directly into the contract ("if you work 52 weeks a year, you only get paid 50% for the 52nd week"), but for various reasons that isn't possible, and the second-best solution is to provide paid vacation.

  2. Paid vacation resolves a bad signaling equilibrium, where everyone feels obligated to put in full hours to signal that they are hard-working and deserve advancement in the company. Offering paid time off convinces enough people to take vacations to break this equilibrium, making virtually everybody happier and better off. (Of course, this could also make the signaling problem worse. How do you signal that you're really hard-working and really devoted to your employer? By not taking paid leave!)

  3. Paid leave makes leisure time more enjoyable, since you're not incessantly bothered by the fact that you're losing money by being away from work. Employees are willing to sacrifice wages and flexibility for this psychological comfort.

  4. By encouraging every employee to be away from work for a brief period each year, paid leave allows a "dry run" to see how the workplace might function without that person, ensuring that it's not overdependent on the contributions of a single individual. This reduces the risk from employee attrition and diminishes the bargaining power of workers who might otherwise claim they were indispensable.
Of course, signaling acts as a powerful force against paid leave as well. Suppose that two otherwise identical companies, A and Z, differ in their vacation policy: company A offers higher wages but no paid vacation, while Z has slightly lower salaries and paid leave. In general, who will choose to work at company Z instead of A? People who like to take time off! To the extent that this is correlated with general laziness (not easily detectable in other ways at the hiring stage), it will make company Z's labor pool less effective, discouraging it from offering paid leave in the first place.


LemmusLemmus said...

"Paid vacation resolves a bad signaling equilibrium, where everyone feels obligated to put in full hours to signal that they are hard-working and deserve advancement in the company."

I live in Germany (where five weeks per year is the standard) and once discussed with a friend whether he might leave the country to work in the US, but he said two weeks vacation were not enough for him. At my suggestion that more vacation time is a question of negotiation he replied (probably correctly) that it wouldn't be so easy "to exclude oneself from the cultural standard" (or some such thing). Hence he (who is pretty hardworking) is unlikely ever to migrate to the US.

I guess mandating long holidays leaves people on average better off (due to the very signaling/equilibrium issues you discuss), but who knows.

James said...

Related to 4, some companies force employees to use their leave every few years. This could be for the reason you give or for the related reason that employees' fraud is most easily discovered once other people have to cover their job.

dj2 said...

Paid Vacation also implies that they expect you don't like your job. Unless you end up with a job like these guys are doing:

While searching for paid vacation, I don't know if I could do it. But it sure makes this discussion a lot easier if you could.

Anonymous said...

I agree with the analysis, but I think the paid vacation signal is very industry dependent. For example, traders at investment banks are required each year to take at least 5 days off, and it serves both the employees and employers purposes. The employer needs at least 5 days to audit the trade books of the trader and the employee gets a psychological break under the guise that his choice of vacation is both out of his control and completely necessary.

Anonymous said...

There is a simpler reason for why paid vacation exists. It's a method of uncovering unwanted behavior in an organization. If someone never takes anytime off they can cover for mistakes or even unethical behavior because they are there to field requests. If they are not there the chances of discovering this behavior increases.

Nancy Lebovitz said...

Are all employee's work evaluated during vacations, or just those in a position to embezzle?

Is it more possible these days to keep embezzlement going from remote locations?