Efficiency wages: Variants and implications

Abstract

1 1 ElEVatOr Pitch Higher wages increase labor costs but also improve the productivity of the labor force in several ways. If firms take this into account and set their wages accordingly, the resulting wages could fail to adjust demand and supply but may induce phenomena like over-education, discrimination, regional wage differentials, and a tendency for larger firms to pay higher wages. All these phenomena are quantitatively important and well-established empirically. Efficiency wage theory provides an integrated theoretical explanation rather than a sundry list of reasons, and offers an efficiency argument for progressive income taxation. aUthOr'S MaiN MESSaGE Labor markets are usually treated like commodity markets, where quality is well-defined and demand and supply are equated by price. However, wages, unlike prices, serve several further functions that affect profitability beyond attracting workers. With higher wages, more demanding hiring standards can be implemented and better workers hired, labor turnover and associated turnover costs can be reduced, and better worker attitudes can be kindled. The efficiency wage approach leads to a unified understanding of some important empirical phenomena and entails some unorthodox policy conclusions, such as the idea that progressive taxation enhances efficiency. Efficiency wages: Variants and implications Wages affect productivity and non-wage costs; this carries important labor market and policy implications