Economics
Efficiency Wages
Efficiency wages refer to higher-than-market wages paid by firms to increase worker productivity and reduce turnover. This concept suggests that paying workers more than the equilibrium wage can lead to improved performance, reduced shirking, and lower labor turnover, ultimately benefiting the firm. This approach is based on the idea that higher wages can motivate employees to work more efficiently.
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11 Key excerpts on "Efficiency Wages"
eBook - PDFWages And Wages Policies: Tripartism In Singapore
Tripartism in Singapore
- Chong Yah Lim, Nanyang Technological Univ, Rosalind Chew(Authors)
- 1999(Publication Date)
- World Scientific(Publisher)
The recent experience in Singapore's labour market suggests that turnover (so-called job-hopping) has become a notable issue in some industries. Under the seniority-based wage system, starting pay for entrants falls behind the market rate under some circumstances, while the pay for senior insiders in some cases probably lacks stimulating impetus to extract the maximum amount of effort. Thus, the adoption of the flexible wage system is a step in the right direction in contributing to narrowing the inefficiency gap between actual wages and the level of efficiency wage, maintaining productive efficiency, and retaining a competitive edge in the world market. 4 The central premise of the efficiency wage literature is that reducing wages could be costly for firms because worker productivity is positively related to wages. Some economists cite adverse labour sorting as a reason for the negative impact of a fall in wages on productivity. Weiss (1980), for example, argues that a wage cut tends to lower the quality of the labour force, so that an efficiency wage could be above the market-clearing level when the marginal cost of employing lower-quality workers exceeds the marginal benefits from reduced labour costs. Besides the adverse-selection argument, another branch of the literature cites workers' moral hazard as a further explanation on why incumbent workers' acceptance wages correlate positively with their productivity. With work effort being difficult to monitor and thus not explicitly specified in the employment contract, work intensity tends to depend upon the cost of dismissal to the worker. 5 2 In the notion of Efficiency Wages, the efficiency or productivity of a worker is an increasing function of the worker's wages. For the pioneering work on the efficiency wage theory, see Solow (1979).
eBook - ePubMorality, Rationality and Efficiency
New Perspectives on Socio-economics
- Richard M. Coughlin(Author)
- 2016(Publication Date)
- Routledge(Publisher)
3 Markets, Competition, and Efficiency
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6 The Socio-Economics of Labor ProductivityPETERB.DOERINGERInstitutional economists have frequently observed systematic differences among firms in their wage strategies (Dunlop, 1957; Doeringer and Piore, 1985; Hildebrand, 1963). Some firms deliberately adopt policies of paying high wages, others pay the "going or average" rate, and still others offer below-average compensation (Reynolds, 1951). More recent quantitative studies of inter-establishment wage structures confirm this finding and there is evidence that these pay differences persist over long periods of time (Groshen, 1988a, 1988b).One interpretation of this finding is that apparent differences in pay by firm or by industry simply relfect differences in worker productivity or in the nonpecuniary aspects of jobs; a second is that pay is not uniquely a function of labor force quality so that earnings can also depend on the firm or industry in which a worker is employed (Katz, 1986). The latter interpretation has led to a body of "efficiency wage" theory postulating a causal relationship between above-market pay premiums and higher profits (Groshen, 1988a, 1988b).Most of the economics literature explaining how pay is related to labor efficiency sees high wages as a means of overcoming market failures that result in principal-agent problems and other sources of allocative inefficiency. There are several different versions of efficiency wage theories—selection and matching, turnover, and monitoring/motivation—each positing a different set of stylized facts about the workplace (Katz, 1986; Weiss, 1990).Selection and matching theories postulate the existence of certain hard-to-measure abilities that are particularly productive under some technologies and work settings. Where such abilities are required, employers seek efficient ways of recruiting such workers. Under the assumption that the reservation wages of workers with these "superproductive" qualities are higher than those of other workers, high wage employment offers can lower recruitment costs by expanding the pool of qualified applicants and improving the efficiency of worker-job matching (Weiss, 1980,1990; Katz, 1986; Weitzman, 1989).
- Morris Altman(Author)
- 2020(Publication Date)
- Academic Press(Publisher)
Blanchflower & Oswald, 1995 ).Efficiency wage theory revised
The contemporary efficiency (Akerlof, 1980 , 1982 , 1984 ; Akerlof & Yellen, 1986 , 1988 , 1990 ) wage literature attempts to address the stability of Efficiency Wages in the face of persistent unemployment or access supply on the labour market. The essence of the argument is that Efficiency Wages are stable given that they are consistent with the profit maximizing objective function of firms or employers. If employers as a group can be assumed to be profit maximizers than any deviations from Efficiency Wages will generate lower profits. The latter scenario is completely consistent with Leibenstein’s modelling. In this case, each firm acting independently—no collusion is required—will pay Efficiency Wages. Thus, even if surplus labour attempts to bid wages down, employers will not accept these bids since lower wage offers would negatively affect profits (net revenues in Leibenstein 1958 ) through their negative impact upon the level of effort inputs.I reconstruct the case for the stability of Efficiency Wages, absent collusion, adapting with some liberty Leibenstein’s graphic representation of ‘Efficiency Wages’. In standard neoclassical theory surplus labour results in lower real wages and more labour is employed, given the existence of effective demand for labour’s output, along the economy’s labour demand curve which is derived from the individual firms’ marginal product of labour curve. Profit maximizing firms accept lower real wage bids by the unemployed for employment. But in the traditional neoclassical narrative, the marginal product of labour curve is invariant to changes in the wage rate. In Fig. 7.3 , for markets to clear at labour supply N2 , the wage diminishes to W2 along marginal product of labour curve MP1 . But according to the ‘efficiency wage’ story, the marginal product of labour curve shifts inward with decreases to real wages. In this scenario, where the marginal product of labour curve shifts to MP2 , the market clearing wage remains at W2 . But this is no longer the revenue maximizing real wage, which in Leibenstein’s narrative determines the preferred real which wage of rational maximizing employers. Rational employers would choose wage rate W1 which is associated with marginal revenue curve MP1 , since this wage-marginal revenue combination maximizes net revenue—the area above W2 in MP1 is less than the area above W1 in MP2 . However, with the higher real wage there are fewer workers employed (N1 as opposed to N2
eBook - ePubIntermediate Microeconomics
Neoclassical and Factually-oriented Models
- Lester O. Bumas(Author)
- 2015(Publication Date)
- Routledge(Publisher)
There are two reasons for the association of the efficiency wage with unemployment. First, it allows an employer to attain a given rate of output with fewer employees. Second, assuming unemployment exists, the efficiency wage is not reduced to equilibrate the market because that would lower both productivity and profits. Thus, the maintenance of unemployment.Fair questions regarding the efficiency wage model are: If the efficiency wage is more profitable than the market wage why is the market wage not increased to the efficiency level? Is the failure to pay the efficiency wage irrational?The Insider-Outsider Model
The insiders in this model are the employed. The outsiders are the unemployed. The insiders have more bargaining power than the outsiders, power which allows them to obtain a higher-than-market wage. The power of the insiders is in the area of transaction costs. The termination of an insider tends to involve severance and morale costs. The employment of an outsider tends to require spending on search and on-the-job training. The greater these transaction costs are, the greater is the ability of insiders to attain above-market wages. This creates an incentive for insiders to increase transaction costs. If workers are represented by a union, for example, an increase in severance pay would do just that as would an arbitration or work stoppage challenging the termination of an insider.What about unemployed workers willing to work for lower pay than insiders? To successfully underbid insiders, outsiders would have to accept pay lower than insiders by at least transaction costs. And, if they did, insiders might take steps costly to the employer. Senior workers are frequently used to informally train new hires in the most efficient ways of accomplishing work tasks. That informal help could be curtailed. And production is frequently accomplished by teams, and aspects of teamwork could be reduced. As a consequence of the transaction and other costs, insiders are hypothesized as being able to obtain and maintain a wage higher than market clearing.
eBook - ePubRenaissance in Behavioral Economics
Essays in Honour of Harvey Leibenstein
- Roger Frantz(Author)
- 2007(Publication Date)
- Taylor & Francis(Publisher)
The contemporary efficiency wage literature, especially that related to the work of Akerlof, ties the notion of Efficiency Wages to the world of developed economies wherein wages affect the level of effort input through their motivational effects on workers. In Leibenstein’s narrative the latter step is missing, at least explicitly, as he draws a direct and tight link between wages and caloric intake and effort input. In the contemporary narrative, effort input is increased with higher wages as higher wages are a proxy for fairness and the like. But no detailed discussion is provided with regards to how wages per se fit into the overall industrial relations bundle. At best, the wage rate is viewed as a proxy for all that motivates workers (Altman, 2002). But the bottom line in this literature, as in the Leibenstein narrative, is that there is a unique net revenue or profit-maximizing “efficiency wage,” whatever its psychological or sociological determinants.It is also important to note an important distinction between Leibenstein’s solution to involuntary unemployment, which amounts to featherbedding, and one proposed in the contemporary efficiency wage literature. such as articulated in Akerlof et al. (2000). Leibenstein argues that firms must hire more workers than would be consistent with profit maximizing so as to prevent real wages from being bid downwards through the excess supply of labor. Therefore, workers would be employed whose marginal product is less than their real wage. If employers failed to do so – and failure is assured absent a resolution to fundamental coordination problems – then real wages and net revenue would fall. In the contemporary efficiency wage literature, no coordination problem presents itself, so the efficiency wage is stable – as would be a certain amount of involuntary unemployment. However, Akerlof et al.
eBook - ePubModern Labor Economics
Theory and Public Policy
- Ronald G. Ehrenberg, Robert S. Smith(Authors)
- 2017(Publication Date)
- Routledge(Publisher)
Journal of Labor Economics 15 (April 1997): 318–337.34 It should be clear that the efficiency wage refers to all forms of compensation, not just cash wages. Lawrence Katz, “Efficiency Wage Theories: A Partial Evaluation,” in NBER Macroeconomics Annual, 1986 , ed. Stanley Fischer (Cambridge, MA: MIT Press, 1986); Joseph E. Stiglitz, “The Causes and Consequences of the Dependence of Quality on Price,” Journal of Economic Literature 25 (March 1987): 1–48; and Kevin M. Murphy and Robert H. Topel, “Efficiency Wages Reconsidered: Theory and Evidence,” in Advances in Theory and Measurement of Unemployment , eds. Yoram Weiss and Gideon Fishelson (London: Macmillan, 1990), offer detailed analyses of efficiency-wage theories.35 Janet Yellen, “Efficiency Wage Models of Unemployment,” American Economic Review 74 (May 1984): 200–208; and Andrew Weiss, Efficiency Wages: Models of Unemployment, Layoffs, and Wage Dispersion (Princeton, NJ: Princeton University Press, 1990).36 Richard Thaler, “Anomalies: Interindustry Wage Differentials,” Journal of Economic Perspectives 3 (Spring 1989): 181–193; Surendra Gera and Gilles Grenier, “Interindustry Wage Differentials and Efficiency Wages: Some Canadian Evidence,” Canadian Journal of Economics 27 (February 1994): 81–100; and Paul Chen and Per-Anders Edin, “Efficiency Wages and Industry Wage Differentials: A Comparison across Methods of Pay,” Review of Economics and Statistics 84 (November 2002): 617–631.37 Alan B. Krueger, “Ownership, Agency and Wages: An Examination of Franchising in the Fast Food Industry,” Quarterly Journal of Economics 106 (February 1991): 75–101; Erica L. Groshen and Alan B. Krueger, “The Structure of Supervision and Pay in Hospitals,” Industrial and Labor Relations Review 43 (February 1990): 134S–146S; Carl M. Campbell III, “Do Firms Pay Efficiency Wages? Evidence with Data at the Firm Level,” Journal of Labor Economics 11 (July 1993): 442–470; Bradley T. Ewing and James E. Payne, “The Trade-Off between Supervision and Wages: Evidence of Efficiency Wages from the NLSY,” Southern Economic Journal 66 (October 1999): 424–432; and Bjorn Bartling, Ernst Fehr, and Klaus M. Schmidt, “Screening, Competition, and Job Design: Economic Origins of Good Jobs,” American Economic Review
eBook - PDFThe Pathology of the U.S. Economy Revisited
The Intractable Contradictions of Economic Policy
- M. Perlman(Author)
- 2002(Publication Date)
- Palgrave Macmillan(Publisher)
Despite such qualifications to the theory of high wages, maintaining a healthy rate of wage growth offers a far more promising outcome than attempting to compete by depressing wages. Efficiency Wages I want to explore in more detail the notion that high wages can improve the human element in the production process. I cannot do much better in this respect than to cite Alfred Marshall, the author of the leading textbook on economics during the first quarter of the twentieth century. Marshall wisely observed: [I]t was only in the last generation that a careful study was begun to be made on the ef- fects that high wages have in increasing the efficiency not only of those who receive them, but also of their children and grandchildren. In this the lead have been taken by Walker and other American economists; and the application of the comparative method of study to the industrial problems of different countries of the old and new worlds is forcing constandy more and more attention to the fact that highly paid labour is gener- ally efficient and therefore not dear labour. [Marshall 1920, p. 510] This statement is interesting in several respects. First Marshall's reference to children and grandchildren-to which I will return later-indicates how high wages can changes workers' character so profoundly that the benefits will carry over to their chil- dren and grandchildren. This phenomenon is relevant to the earlier discussion of the contemporary crisis in education in the United States. Secondly, Marshall's uses of the term "forcing" serves as a reminder that most busi- ness people and economists still resist the notion that "highly paid labour is generally efficient and therefore, not dear labour," although, as I shall discuss later, some larger firms are more aware of the benefits of high wages. Finally, Marshall knew that the United States paid higher wages than anywhere else and that its economy was the most powerful in the world.
eBook - PDF- M. Zagler(Author)
- 2004(Publication Date)
- Palgrave Macmillan(Publisher)
Whilst one can hardly verify the degree of motivation or the quality of organization, the firing rate is readily accessible, hence firm owners (shareholders) may prefer efficiency-inducing mechanisms that operate through wage premia, requesting high external efficiency, that is a high μ, and thus indirectly foster unemployment. Profit maximization in manufacturing implies that firms will increase their wage until the increase in effort is just offset by an altern- ative increase in employment, that is until the output elasticity of employment is equal to the output elasticity of the wage rate, ∂ e i,t ∂ w i,t w i,t e i,t = 1, (2.10) 30 Theory Any firm will increase (reduce) its wage relative to the average wage, whenever unemployment exceeds (lies below) μ. This will equipropor- tionally increase (reduce) the average wage, thus inducing another round of relative wage increases (declines), implying ultimately that wages will increase without bound (decline to a zero rate). Hence a third interpretation of μ is the manufacturing non-accelerating wage rate of unemployment (Nawru), as the specific functional form of the efficiency function reduces equation (2.10) to, μ = w i,t w t u t , (2.11) The efficiency condition (2.10) implies that productivity in manufactur- ing will equal unity, e i,t = 1. (2.12) When setting prices, firms maximize profits subject to demand (2.6) and technology (2.9), which yields the following first-order condition, p i,t = ε ε − 1 w i,t e i,t , (2.13) stating that the price the firm charges equals the mark-up over costs, the wage in efficiency terms. Note that the manufacturing sector is com- pletely symmetrical, as every firm will choose identical efficiency levels because of equation (2.12), set identical wages because of equation (2.9), and identical prices because of equation (2.13).
eBook - PDF- Konstantinos Tatsiramos, Solomon W. Polachek(Authors)
- 2013(Publication Date)
- Emerald Group Publishing Limited(Publisher)
CONCLUDING REMARKS This chapter provides a model of efficiency-wage competition along the lines put forward by Hahn (1987) . Specifically, I build a two-firm effi-ciency-wage model in which workers’ effort attainable by the representative firm is an increasing function of its own wage offer but declining in the offer put forward by its competitor. As a consequence, employers screen their workforce by means of increasing wage offers competing one another for high-quality employees. The main results achieved in this theoretical analysis can be summarized as follows. First, using a specification of effort such that the maximum profit problem of the representative firm is well-behaved in the sense that it does not deliver corner solutions, optimal wage offers are strategic comple-ments, i.e., whenever the competitor increases (decreases) its wage offer, the optimal response for each firm is to rise (decrease) its wage offer as well. Second, the symmetric Nash equilibrium can be locally stable under the assumption that each firm adjusts its optimal wage offer in the direction of increasing profits by conjecturing that any wage offer above (below) equili-brium will lead the competitor to underbid (overbid) such an offer. Finally, the exploration of possible labor market equilibria reveals that effort is counter-cyclical, i.e., equilibria with higher (lower) unemployment are char-acterized by higher (lower) effort levels. 204 MARCO GUERRAZZI NOTES 1. By contrast, macroeconomic interventions such as expansionary monetary policies could be more effective in this direction. 2. A more general Stackelberg version of Hahn’s (1987) model in which wages are endogenously determined is derived in Appendix A. 3. An equivalent reading of the Solow (1979) condition provides that firms set the wage employment pair in order to minimize the cost of labor in terms of effi-ciency, i.e., in order to minimize the wage-effort ratio (e.g., Lindbeck & Snower, 1987 ).
- Richard Sabot(Author)
- 2019(Publication Date)
- Taylor & Francis(Publisher)
High capital/labor ratios mean that wage costs are a small proportion of value added and that quite significant wage increases may have only a small impact on total costs. Moreover, many large-scale, capital-intensive enterprises operate behind tariff barriers that allow them to pass on costs to consumers as higher prices. It is necessary to assess the 234 Richard H. Sabot contribution to the increase in productivity of such factors as shifts toward more productive enterprises, changes in technology, and improvements in management or organization. If these are shown to be unimportant, so that there is a reasonable presumption that rising productivity is not the cause of rising wages, there remains the issue of how far higher productivity is simply the result of capital deepening induced by higher wages. All of the above suggests that tests of the hypothesis that increasing wages above the market clearing level minimizes labor costs will have to be conducted with highly disaggregated data, probably at the level of individual firms. Even then it is not sufficient just to demonstrate that higher wages result in higher productivity among workers who are homogeneous in other respects. 4 Rather, the wage elasticity of supply of efficiency units per worker must ex-ceed unity. Otherwise the wage-related benefits to employers from increased productivity (or decreased nonwage costs of labor) will not exceed the costs of increased wages, implying that conventional labor market clearing adjust-ments take place through numbers hired and wage rates. To measure this elasticity of supply with precision, detailed measures of productivity, which are difficult to obtain, will be necessary.
eBook - ePub- Hilde Behrend(Author)
- 2016(Publication Date)
- Routledge(Publisher)
Another example may be useful in illustrating the different effects of effort and marginal productivity evaluations. With better methods of production, worker efficiency (output per unit of time) may increase while effort remains the same or decreases. Marginal productivity, provided there is no change in the market value of a unit of output, thus increases while effort remains constant. Under such conditions, many employers who use time-study methods do not permit a rise in earnings to take place. They deliberately adjust the piece-rate price so that earnings on the particular job remain the same (23). In fact, they reward not marginal productivity but effort. They assess the effort cost of performing different tasks; they evaluate this effort cost, not in terms of money, but in terms of ‘real’ costs, of disutility or irksomeness. The managerial aim is to ascertain whether the effort cost of two operations is equal or not, and to try to equalise it or, if there are unavoidable differences, to arrange for compensation (24).The manager’s and the economist’s system of beliefs are thus seen on closer examination to focus attention on two distinctly different elements in wage determination; effort evaluations, where standards of effort and their effort cost are assessed in relation to each other, as opposed to market evaluations, where labour productivity is assessed in relation to market prices as represented by the concept of marginal value productivity (25).A wage policy based on effort evaluations reflects the disutility of labour, Marshall’s ‘real costs’ (26). This means that economists may have been overhasty insofar as they have dispensed with the concepts of real costs and disutility of labour, in connection with wage determination (27). On the other hand, it would be equally hasty to dispense with the concept of value productivity. The two aspects of the problem of wage determination are interrelated: the wage rate must be right in relation to effort standards and right in relation to the market. It is thus likely that product prices set limits within which effort evaluations are made and that market and real cost calculations are interlinked (28).The interviews on financial incentives provided little information about how economic judgements of profitability and market prices enter into wage determination. Statements made by management officals with regard to the share of management and workers in increased productivity (29) showed that they did not ascribe the division of the shares to economic forces; while they considered that the determination of the share of the consumer depended on market forces, they attributed the shares of management and workers to normative forces, to what appeared ‘right’ and ‘fair’ and to ‘what should be done’. The concept of profitability entered only as a normative criterion – not as an economic one – as illustrated by the statement that ‘a fair part of the gain should go to management and to increase the prosperity of the company’.
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