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Andrew Blackwell
B.A. Philosophy & Economics, 3d Year 19F Westbourne Terrace London W2 3UN Class C

Introduction In recent years, much economic theory and research has looked at the phenomena of wage rigidity and involuntary unemployment1, and within the domain of labour economics much attention has been devoted to the phenomenon of inter-industry wage differentials. Many theories have sprung up to explain these phenomena, and one of these, Efficiency Wage Theory, has attempted to shed light on all three of them. In short, Efficiency Wage Theory states that the productivity of workers depends positively on their wages, and elucidates certain mechanisms that explain this dependence.

Efficiency Wage Theory

In this essay I would like to briefly describe the Efficiency Wage Theory and the models that constitute it. Then I shall go on to explain what implications the theory has for the clearance (or non-clearance) of labour markets. Subsequently I will look at the empirical research that has been undertaken in this field, pointing out certain methodological problems on the way. To conclude I will argue that Efficiency Wage Theory has strong backing, but that it is not sufficient to as a monocausal explanation for the above phenomena, and that other models can still serve as strong complements in explaining contemporary labour market setups. Efficiency Wage Theory Model and Sub-models

Quoted References: • • • • • G.J. Borjas, Labour Economics (McGraw Hill, 1996) S. Polachek and W.S. Siebert, The Economics of Earnings (Cambridge University Press, 1993) D.I. Levine, "Can wage increases pay for themselves? Tests with a production function", Economic Journal, September 1992 C.M. Campbell and K.S. Kamlani, "The reasons for wage rigidity: evidence from a survey of firms.", Quarterly Journal of Economics August 1997 J. Agell and P. Lundborg, "Theories of pay and unemployment: survey evidence from Swedish manufacturing firms", Scandinavian Journal of Economics June 1995

The efficiency wage model asserts that the productivity of workers in firms is positively correlated with the wages they receive. The model has different explanations as to why this is the case. These explanations in turn can be seen as sub-models to the efficiency wage model2: • • • • Shirking Model3: If workers receive a higher wage, the cost of losing their job becomes higher, and this acts as an incentive for workers not to shirk and risk being fired. Gift-Exchange Model4: A higher wage is seen by workers as a gift from the firm, and workers will want to return this gift in the form of higher effort. Fair Wage-effort Model5: If workers were paid a wage below what they perceived as fair, they would not apply as much effort as when they got a "fair" wage. Adverse Selection Model6: A wage which is above the labour-market equilibrium wage will draw more workers to the gates of the firm, thus allowing the firm to choose better workers from a bigger pool.

Total length of essay: 1948 words

1Agell

& Lundborg 1995:295 & Kamlani 1997:760 3attributed to Shapiro and Stiglitz 1984 4Akerlof 1982, 1984 5Akerlof 1990; Campbell and Kamlani don't actually consider this to be part of the efficiency wage model, but I will include it, since it also correlates higher wages with efficiency and could logically be likened to the giftexchange model (ie instead of a higher wage being perceived as a gift, a lower wage would be seen as an unfairness, which in effect is explaining the same phenomenon from two different psychological viewpoints). 2Campbell



Turnover Model7: If workers are paid a higher wage than they would get at other firms, they are less inclined to quit their jobs, thus decreasing the firm's turnover. The firm thus saves itself the costs of hiring and training new workers.

There is no simple solution to the first problem, but an important implication of it is that the empirical studies I will use relating to the theory are of two largely...
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