Efficiency Wages


What are the The Wages for Efficiency?

In the field of labor economics efficiency wages are an amount of money which are paid to employees above that of the the minimum wage in order to keep the most skilled and productive workforce. The theory of efficiency wage states that an employer should pay its employees at a high level to incentivize workers to perform well and highly skilled workers don’t quit. Efficiency wages could be offered to employees who need a significant amount of trust, such as those who work in precious metals, jewelry or finance to keep them loyal.

The efficiency wage theory can help explain why businesses appear to overpay for labor , arguing that higher wages increase the overall efficiency and profitability of an organization in the long term.

Understanding the concept of efficiency wages

Efficiency wages were thought of in the 18th century, and the famous social economist Adam Smith identified a form of wage disparity in which employees in certain sectors are paid higher than others due to the degree of trustworthiness needed. In one instance Smith observed that workers employed by jewelers or goldsmiths are often equally skilled as blacksmiths, or other craftsmen were paid a higher rate each hour. 1 Smith believed that this was because of the need to encourage these workers to avoid taking these products that are more valuable.

In more contemporary contexts the term “efficiency wages” refers to the fact that a lot of employers don’t cut wages to minimal wage even in presence of competition from other companies or in times of recession , when a large workforce of people who are unemployed is available. This is an issue for economists who believed that business owners who are rational and have efficient labor markets should aim to keep the wages as low as is possible.

The solution to this problem is that efficiency wages resolve the principal-agent issue so that, with these high salaries employers would have a difficult time to keep their employees engaged and loyal.

Why should you pay for efficiency wages?

The economists have discovered a number of motives for employers to pay more efficient salaries to employees. 2 3


The most commonly used are:

  • Reduce turnover of employees Increased wages can discourage employees from quitting. This is particularly true if recruiting and training new employees is a costly and time-consuming process.
  • Improve morale Additionally an efficiency pay raise can make employees happier and reduce the number of unhappy employees who could lower morale in the workplace and reduce production.
  • Improve productivity Pay rises result in more productive employees who create more goods per hour and put in more effort. They also decrease shirks (being lazy at work) and decrease absences.
  • To retain and attract skilled workers Unskilled workers might be considered to be somewhat similar from the point of view of management however, highly skilled workers are typically in greater demand and less available.
  • Loyalty and trust High-paying workers are likely towards being more committed to the company and are from being prone to theft from or reduce the profits of the company.

Efficiency Wage Theory

The concept of efficiency wages has been around for a few years, this concept established by economists in the second quarter of the 20th century. Examples of this include Joseph Stiglitz and his research on shirks. In collaboration with his fellow colleagues Stiglitz suggested that when unemployment is high, those who have been dismissed are able to find new work. However, this situation increases the likelihood that a worker will be excused for being unproductive or lazy (i.e., “shirk on the job”). Since shirking lowers the company’s profits and profits, employers are compelled to increase wages to stop this from happening and to motivate their employees. 2 Stiglitz received the Nobel prize in economics in 2001, primarily due to his work.

George Akerlof also a Nobel prize winner, also was a researcher on the efficiency of wages, suggesting that wages will remain ” sticky,” even during times of economic turmoil which is why employers don’t lower the wages that their staff members earn. Instead, in order to reduce costs employers may fire employees (instead of hiring more employees with lower salaries). But, this can increase the percentage of involuntary unemployment. Pay is not set by the market for employment , but rather by the efficiency goals of companies which must employ the best workers. Akerlof who was working alongside Janet Yellen said that companies can reduce the cost of training and hiring by laying off workers as the economy is struggling instead of reducing wages for all its employees throughout the world.

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