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Efficiency wages

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This RePEc Biblio topic is edited by Ekkehart Schlicht. It was first published on 2019-06-04 08:03:31 and last updated on 2021-06-05 07:12:10.

Introduction by the editor

Firms may find it of advantage to pay wages in excess of what is needed to attract sufficiently many applicants for its vacancies. Such wages are known as efficiency wages. In other words, an efficiency wage exceeds the reservation wage, which is the wage that makes an applicant indifferent between accepting the job at that wage, or taking the next best alternative - be it another employment, be it unemployment, with or without further search.

A brief introduction to efficiency wage theory can be found in Yellen (1984). Some empirical regularities related to efficiency wages are diecussed in Schlicht (2016). Efficiency wages come in four (not mutually exclusive) flavors. Wages exceeding reservation wages may permit to establish better work discipline, reduce labour turnover and turnover costs, permit recruiting a more productive work force, and establish a better work morale.

In each case, an increasing wage in one firm may enhance to productivity of that firm but will, by the same token, reduce the productivity of other firms that keep their wages constant, as the wage of the workers in these other firms will be reduced in relative terms. This weakens the disciplining effect of the threat of dismissal, enhance the prospects of finding a better-paying job, reduce the pool of applicants to select from, and weakening the working morale in the other firms.

Efficiency wages exceed market clearing wages but this does not imply unemployment, as job seekers applying for a high-paying job may be employed at a low wage elsewhere.

The main criticism of efficiency wages is that the stipulated functions of efficiency wages can and are achieved by other means, the defense is to dispute this claim theoretically and empirically.

The main references are:

Discipline: Shapiro and Stiglitz (1984).

Turnover: Schlicht (1978), Salop (1979).

Selection: Weiss (1980), Schlicht (2005).

Morale: Solow (1979), Akerlof (1982).

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Most relevant research

  1. Edmund S. Phelps, 1968. "Money-Wage Dynamics and Labor-Market Equilibrium," Journal of Political Economy, University of Chicago Press, vol. 76, pages 678-678.
  2. Joseph E. Stiglitz, 1974. "Alternative Theories of Wage Determination and Unemployment in LDC's: The Labor Turnover Model," The Quarterly Journal of Economics, Oxford University Press, vol. 88(2), pages 194-227.
  3. Schlicht, Ekkehart, 1978. "Labour Turnover, Wage Structure, and Natural Unemployment," Munich Reprints in Economics 1255, University of Munich, Department of Economics.
  4. Salop, Steven C, 1979. "A Model of the Natural Rate of Unemployment," American Economic Review, American Economic Association, vol. 69(1), pages 117-125, March.
  5. Solow, Robert M., 1979. "Another possible source of wage stickiness," Journal of Macroeconomics, Elsevier, vol. 1(1), pages 79-82.
  6. Weiss, Andrew W, 1980. "Job Queues and Layoffs in Labor Markets with Flexible Wages," Journal of Political Economy, University of Chicago Press, vol. 88(3), pages 526-538, June.
  7. George A. Akerlof, 1982. "Labor Contracts as Partial Gift Exchange," The Quarterly Journal of Economics, Oxford University Press, vol. 97(4), pages 543-569.
  8. Shapiro, Carl & Stiglitz, Joseph E, 1984. "Equilibrium Unemployment as a Worker Discipline Device," American Economic Review, American Economic Association, vol. 74(3), pages 433-444, June.
  9. Yellen, Janet L, 1984. "Efficiency Wage Models of Unemployment," American Economic Review, American Economic Association, vol. 74(2), pages 200-205, May.
  10. Stiglitz, Joseph E, 1987. "The Causes and Consequences of the Dependence of Quality on Price," Journal of Economic Literature, American Economic Association, vol. 25(1), pages 1-48, March.
  11. Ekkehart Schlicht, 2016. "Efficiency wages: Variants and implications," IZA World of Labor, Institute of Labor Economics (IZA), pages 275-275, July.