Efficiency Wages

What are the The Wages for Efficiency?

In economics of labor the term “efficiency wages” refers to an amount of money that are paid to workers over what is considered to be the the minimum wage to ensure that they have the most skilled and productive workforce. The concept of efficiency wage suggests that an employer should pay its employees a fair amount to incentivize workers to perform well and highly skilled workers don’t quit. Efficiency wages can be offered to employees in fields that need a significant amount of trust, such as those who work in the fields of precious metals, jewels or finance, to keep them loyal.

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

Understanding the Efficiency Wages

Efficiency wages were discussed in the 18th century, and the famous economics professor Adam Smith identified a form of wage disparity in which workers in certain sectors are paid higher than others due to the degree of trustworthiness needed. As an example, Smith discovered that people employed by jewelers or goldsmiths are often equally skilled as blacksmiths and other craftsmen, were paid more each hour. 1 Smith thought that this might be because of the need to discourage workers from taking these products that are more valuable.

In more contemporary settings efficiency wages are the fact that a lot of employers are not willing to cut their wages below the minimal wage even in presence of competition from rival firms or in times of economic recessions when the workforce of people who are unemployed is available. This was an issue for economists who believed that business owners with a rational mindset and efficient labor markets must keep the wages as low as is possible.

The answer to this puzzle is that efficiency wage solves the principal-agent dilemma and, without these high salaries employers would have a difficult time to keep their employees productive and loyal.

Why do we pay efficiency wages?

The economists have come up with a variety of reasons for employers to pay more efficient salaries to employees. 2 3


The most popular are:

  • Reduce the rate of employee turnover Increased wages can discourage employees from quitting. This is particularly important when recruiting and training new employees is a lengthy and expensive process.
  • Increase morale Additionally an efficiency wage could make employees happier and reduce the number of unhappy employees who could lower morale in the workplace and slow production.
  • Enhance productivity Pay rises will result in more productive workers who can produce more products per hour, and also put forth more effort. They also decrease shirks (being lazy at work) and reduce absences.
  • Retain and recruit skilled workers Although workers who are not skilled could be seen as similar from the point of view of management however, highly skilled workers are typically in greater demand and less available.
  • Loyalty and trust The higher-paying employees tend towards being more committed to the company and are much from being prone to theft from or lower the bottom line of the company.

Efficiency Wage Theory

The concept of efficiency wages is a concept that has existed for several years, this concept established by economists in the second quarter of the 20th century. Some notable examples are Joseph Stiglitz and his research on the concept of shirking. In collaboration with his fellow colleagues Stiglitz suggested that when unemployment is high, employees who are fired can find new work. But, this also increases the chances that an employee will be excused for being lazy or inefficient (i.e., “shirk on the job”). However, as shirking can reduce the profitability of a company and profits, employers are compelled to increase wages to stop this from happening and to motivate their employees. 2 Stiglitz was awarded the Nobel prize in economics in 2001, primarily due to his work.

George Akerlof also a Nobel prize winner, also focused on the issue of efficiency wages by proposing the idea that wages stay ” sticky,” even during times of economic turmoil in which employers do not lower the wages for their workers. Instead, to save money employers fire employees (instead of retaining more employees who earn a lower wage). This increases the amount of unemployment that is involuntary. The wages of workers are not defined by a market for jobs but rather the goals of productivity for firms who must hire those with the highest level of expertise. Akerlof who was working alongside Janet Yellen suggested that businesses can reduce the cost of training and hiring by cutting some employees as the economy is struggling instead of reducing wages for all its employees in all.

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