Efficiency wage

In economics, an efficiency wage is understood to be a wage that is above the equilibrium level and that an employer pays voluntarily in order to increase labor productivity, reduce staff turnover costs, recruit the most productive workers or raise labor standards.

Differentiated according to neoclassical , sociological and psychological models, the article shows the motivation for paying efficiency wages. The so-called Shirking approach, the fluctuation cost argument and the theory of adverse selection fall into the neoclassical area . In social efficiency wage theories, social norms and interactions between people are seen as having a decisive influence on human behavior. The extent to which this influence has to be taken into account when structuring efficiency wages is described in the fair-wage / effort model and the gift exchange approach. The equity theory illuminates the subject of efficiency wages from a psychological perspective.

Neoclassical

The neoclassical models are based on the fact that there is a positive relationship between wage levels and labor productivity. It can therefore be of interest to a company to pay a wage that is higher than that which is clearing the market. In addition, they assume that employees behave in a way that maximizes individual benefits . Only wages and work effort are assumed as arguments of the utility function . A higher wage and less work effort increase the individual benefit.

No-shirking

A wage above the market clearing level leads to unemployment ${\displaystyle \textstyle w_{G}}$

The shirking approach, takes that complete monitoring ( monitoring ) is possible the workforce. According to Shapiro and Stiglitz (1984), workers can choose to work or to stroll (Shirking). There is a certain probability that workers who are strolling around will be spotted and then fired. Therefore, a wage that is higher than the market-clearing wage can be an effective way for the company to encourage employees not to stroll.

If all firms pay the efficiency wage, there is equilibrium unemployment , which increases the costs of a discovered worker and thus his incentive to work. The existence of unemployment is of great importance here, as without it there would be no cost of strolling, as every laid-off worker would immediately find new employment. Without unemployment, all workers would loiter because they prefer to do nothing. The unemployed are also not reinstated by offering to work for a lower wage, as the company anticipates that they would stroll for wages below the efficiency wage. There is no way to make believable that the worker is working for a lower wage. A Pareto optimum with cost-causing monitoring brings unemployment with it, as it gives positive work incentives. However, the equilibrium unemployment rate is not Pareto-optimal because companies do not take into account the social costs they cause by the high unemployment rate.

One way to improve this is to have the employee leave a deposit when starting work . However, this assumes that the employees have sufficient equity. If workers are caught strolling, they lose bail and - if all companies ask for bail - they have to pay another bail to another employer in order to be reinstated. However, the problem of moral hazard on the part of the company arises here . It would have an incentive to put workers on the loose and thus keep their bail and to be able to hire new workers, who in turn deposit a bail.

Another way to solve the incentive problem is seniority pay. The workers are initially paid a wage that is below their productivity and later above it. An employee therefore has no incentive to shirk, as he would lose his future higher wages if he were laid off. However, here too there is a problematic incentive for companies to lay off employees who receive wages above their productivity and replace them with new workers. However, if the level of effort on the part of employees were observable, the company would have no way of cheating the workforce.

Becker / Stigler model

The Becker / Stiegler model is a simplified version for two periods represent. In this case, the employee may choose in each of the two periods, either to show a high effort or low (power reserve, English shirking ). There is a certain likelihood that it will be discovered if it only shows a low job performance. In addition, he receives an immediate pecuniary advantage (for example, through saved work suffering ). If an employee is discovered, this happens at the beginning of the period and he is immediately dismissed without payment. He then does not receive the advantage , but an alternative wage from the next best job. There are: ${\displaystyle \textstyle p}$ ${\displaystyle \textstyle b}$ ${\displaystyle \textstyle b}$

• ${\displaystyle \textstyle w_{1}}$, : Wages of the respective period ${\displaystyle \textstyle w_{2}}$
• ${\displaystyle \textstyle w_{1}^{A}}$, : Alternative wages for the respective period ${\displaystyle \textstyle w_{2}^{A}}$

Period 2

Management tries to set wages in a way that prevents shirking.

The figure shows a minimum wage that is currently preventing the employee from shirking:

${\displaystyle w_{2}=p\cdot w_{2}^{A}+(1-p)\cdot (b+w_{2})}$

resulting in the following wages for period 2:

${\displaystyle w_{2}=w_{2}^{A}+{\frac {1-p}{p}}\cdot b}$

The wages must be all the higher: ${\displaystyle \textstyle w_{2}}$

• The higher the alternative wage, because the higher the opportunity costs for shirking for the employee ${\displaystyle \textstyle w_{2}^{A}}$ ${\displaystyle \textstyle w_{2}^{A}}$
• The greater the shirking advantage , because the greater the shirking incentive for the employee. ${\displaystyle \textstyle b}$ ${\displaystyle \textstyle b}$
• The lower the probability of detection , since the lower the expected opportunity costs for shirking for the employee. ${\displaystyle \textstyle p}$ ${\displaystyle \textstyle p}$

Period 1 is now considered: Here, too, there is a minimum wage that prevents the employee from shirking. denote the interest rate at which the employee's income is earned. ${\displaystyle \textstyle r}$

Period 1

${\displaystyle w_{1}+{\frac {w_{2}}{1+r}}=p\cdot \left(w_{1}^{A}+{\frac {w_{2}^{A}}{1+r}}\right)+(1-p)\cdot \left(b+w_{1}+{\frac {w_{2}}{1+r}}\right)}$

The expression for gives: ${\displaystyle \textstyle w_{2}}$

${\displaystyle w_{1}=w_{1}^{A}+{\frac {(1-p)\cdot b}{p}}\cdot {\frac {r}{1+r}}}$

The following applies to efficiency wages:

• ${\displaystyle \textstyle w_{1}>w_{1}^{A}}$and : In the event of dismissal, the employee has to bear opportunity costs in the form of a lower wage. He is fundamentally interested in continuing to work in this company. ${\displaystyle \textstyle w_{2}>w_{2}^{A}}$
• ${\displaystyle \textstyle w_{2}>w_{1}}$, da : In the first period the employee and would lose if caught shirking. In the second period there is only available to prevent the employee from shirking. Therefore must be set higher than . ${\displaystyle {\tfrac {r}{1+r}}<1}$ ${\displaystyle \textstyle w_{1}}$ ${\displaystyle \textstyle w_{2}}$ ${\displaystyle \textstyle w_{2}}$ ${\displaystyle \textstyle w_{2}}$ ${\displaystyle \textstyle w_{1}}$

Fluctuation cost argument

Another explanatory approach in the area of ​​efficiency wages deals primarily with the importance of costs after termination and new hires. It is based on the assumption that employees quit in order to look for better offers on the job market . Employees have no incentive to change companies if they are paid in their current position that is above average. The fluctuation costs arise directly and indirectly. Directly through interviews or costs through induction; indirectly, costs will arise, for example, through lower productivity during training. These expenses are inevitable for the company, since every new employee, no matter how quickly he replaces the departing employee, has a lower efficiency and thus costs the company more than an experienced employee.

Productivity and optimal wages

As the turnover rate increases, productivity falls. The productivity of a fully trained worker is normalized to 1.

The turnover rate of a company is the ratio between the annual termination of employment relationships and the number of employees. As the turnover rate rises, the proportion of relatively inexperienced workers in the company increases. This suggests a relationship between average labor productivity and turnover, as new workers take time to become familiar with the technology and organization of the workplace.

The higher the wages an employee receives, the less incentive they are to quit, as the likelihood of finding an even better-paying job decreases. The fluctuation rate decreases with increasing wages.

• ${\displaystyle \textstyle w}$: Wages
• ${\displaystyle \textstyle W}$: average wage
• ${\displaystyle \textstyle v={\frac {w}{W}}}$: relative wages

Productivity curve

The productivity curve shows the relationship between relative wages and average labor productivity. Labor productivity rises as the relative wage increases.

The production function of a company is given by: with ${\displaystyle \textstyle Y=F(\alpha \cdot N)}$

• ${\displaystyle \textstyle N}$: Number of employees in this company
• ${\displaystyle \textstyle Y}$: Output
• ${\displaystyle \textstyle \alpha }$: Average productivity

The company maximizes its profit by choosing for a given number of workers and relative wages : ${\displaystyle \textstyle W}$ ${\displaystyle \textstyle N}$ ${\displaystyle \textstyle v}$

${\displaystyle {\underset {v,N}{\max }}\ F(\alpha \cdot N)-v\cdot W\cdot N}$

The optimal demand for labor as a function of the average wage.

From the first-order conditions

• ${\displaystyle \textstyle F'(\alpha \cdot N)\cdot \alpha '\cdot N-W\cdot N=0}$
• ${\displaystyle \textstyle F'(\alpha \cdot N)\cdot \alpha -v\cdot W=0}$

results as the optimal relative wage : ${\displaystyle \textstyle v^{*}}$

${\displaystyle \alpha '(v^{*})={\frac {\alpha (v^{*})}{v^{*}}}}$

and the optimal amount of work the company asks for:

${\displaystyle F'(\alpha (v^{*})\cdot N^{*}(w))\cdot \alpha (v^{*})-v^{*}\cdot W=0}$

unemployment

The fluctuation rate depends not only on the relative wage, but also on the state of the labor market. The higher the unemployment rate, the fewer employees will quit and try harder to avoid being laid off, which increases productivity. On the other hand, when the unemployment rate is low, workers have better prospects of finding better paying jobs, which decreases productivity and leads to excess demand for work.

Productivity now depends on the relative wage and the excess demand for labor and can be written as: ${\displaystyle \textstyle \alpha }$ ${\displaystyle \textstyle v}$ ${\displaystyle \textstyle e}$ ${\displaystyle \textstyle \alpha =\alpha (v,e)}$

• An increase in increases the average productivity ${\displaystyle \textstyle v}$
• An increase in lowers the average productivity ${\displaystyle \textstyle e}$

For a given and with a high unemployment rate, the fluctuation is low and the influence of a wage increase on fluctuation and productivity is small. If, on the other hand, there is a high excess demand for work, the influence of wages on fluctuation and productivity is greater. An increase in excess demand on the labor market shifts the productivity curve downwards. increases. ${\displaystyle \textstyle v}$ ${\displaystyle \textstyle v^{*}}$

All firms try to reduce the turnover rate in their company by increasing wages to a point where the resulting unemployment alone reduces the turnover rate.

balance

In the starting point there is an average wage and a certain excess demand for work . Each company chooses the optimal relative wage and labor demand . This creates a new excess demand , whereupon a new one is elected, which also brings with it a new average wage . This process continues until an equilibrium wage is earned . Wages below this level will increase and wages above this level will decrease so that it stabilizes. In addition, there is a natural surplus demand for labor in equilibrium . ${\displaystyle \textstyle W_{0}}$ ${\displaystyle \textstyle e_{0}}$ ${\displaystyle \textstyle v^{*}(e_{0})}$ ${\displaystyle \textstyle N^{*}(w_{0},e_{0})}$ ${\displaystyle \textstyle e_{1}}$ ${\displaystyle \textstyle v^{*}(e_{1})}$ ${\displaystyle \textstyle W_{1}}$ ${\displaystyle \textstyle {\overline {W}}}$ ${\displaystyle \textstyle {\overline {W}}}$ ${\displaystyle \textstyle {\overline {e}}}$

• A very high wage level leads to a very high unemployment rate. That alone will reduce fluctuation so that no additional wage incentives are necessary. All companies try to set their wages below the average, which leads to a decrease in the average wage level.
• A very low wage level leads to a shortage of work. The turnover rate is so high that it would be detrimental to the company if it did not pay wages well above average. This leads to an increase in the general wage level.

Adverse selection

The theory of adverse selection is based on the assumption that the workforce is heterogeneous and that there is an asymmetrical distribution of information between employer and employee. This is reflected in the employer's incomplete knowledge of the skills of the employees. In order to increase the average quality of employees, the company sets wages in such a way that the labor costs per efficiency unit are minimized. Higher wage offers enable the company to attract the most capable workers from the pool of applicants. A higher wage increases both the number and skills of those who are hired.

Here, too, companies offer wages that are above market clearing wages, which creates unemployment. An unemployed person cannot offer his labor at a lower wage because the company would interpret this offer to mean that the productivity of that worker would be lower than that of workers with a higher acceptability wage.

This makes it clear why companies react to a drop in demand on the goods market with layoffs and not with wage cuts. Wage cuts would mean that the most skilled workers would quit.

The wage here has the additional task of attracting employees with high work performance and serves as an indicator of the quality of work.

Sociological Theories

In the sociological efficiency wage theories, social norms play a role in the individual decision on the level of work effort. Potential influencing variables on the formation of norms are ideas about a fair relationship between work effort and wages, the unemployment rate or the wages of reference groups. It can be profitable for a company to pay a wage above the market clearing level if it increases individual work performance.

The Gift Exchange Approach

The gift exchange approach incorporates traditional sociological aspects into the explanation of efficiency wages. The norms of a working group are a decisive factor influencing the work performance of employees. However, the standard does not have to be identical to the minimum requirement set by the company. Work that exceeds the minimum requirement is considered a gift from the employee to the company. The reason for the gift to the company are friendly feelings for colleagues and the company itself, which the employees develop in their work. These gifts increase the benefits for employees and are based on generally accepted standards. For the gifts, however, the employees also expect a gift in return in the form of fair remuneration and a fair level of minimum work performance. The norm of exertion and the ratio of the exchange of gifts depends on what the employees understand by a reasonable work performance per day. As long as they feel they are being treated fairly, they will do a job that is above the required level. The relationship between labor standards and wages creates a balance in which companies pay a wage above the market-clearing wage and in which there is therefore unemployment. One criticism of this approach can be seen in the employees' positive feelings towards the company, which are proclaimed to be natural behavior.

The fair-wage / effort model

This model assumes that a worker's performance depends on whether he feels his wages are fair. A wage is accepted as fair if the same services are paid equally, the perceived work performance corresponds to the perceived remuneration or if the costs of the employment relationship such as training costs or opportunity costs are reimbursed. Further determinants of the notion of a fair wage are:

• Market-clearing wages: Wage demands are usually above this level. Wages below this level will not be accepted as fair pay.
• Unemployment rate: the higher the unemployment rate, the lower the wage demand that is considered fair.
• Reference groups: Since it is of great importance for employees that the same services are rewarded equally, it is relevant which reference groups are considered when presenting the fair wage. Employees with a selfish point of view are more likely to choose similar workers as a reference group, while employees with a fraternalistic point of view are more likely to compare themselves to different workers.

While underpaid will reduce work effort, overpaid will not further improve the employee's performance. This concept is based on Homans' compensatory justice theory . According to this, a person who is in an exchange relationship with another will expect a proportionality of the exchange. If this law is violated, the disadvantaged person will engage in activities designed to correct the injustice. An employee who, from his point of view, receives too low a wage will accordingly reduce his work management until he considers the relationship to be balanced again.

Psychological approach

Equity theory

In addition to the sociological explanations, the equity theory can explain a similar relationship between wages and performance from a psychological perspective. This theory goes back to Leon Festinger and makes particular reference to the theory of cognitive dissonance . Cognitive dissonance arises when the exchange relationship between work effort and wages is perceived as different by two people. Here, too, the need is awakened to influence the unjust exchange relationship in such a way that justice is achieved. This is always about the individual perception of inputs and outputs. A fair exchange relationship can be achieved through the following options:

• Change in inputs and outputs: The employee can vary the input in the form of his work effort or the output by changing his wages.

• Scope for assessment: inputs and outputs are not one-dimensional, but consist of several components. An example of a change in a component of the inputs would be an individual with a better paid work colleague who receives a higher wage but also has a higher school leaving certificate. The perceived injustice is therefore reduced when the training component becomes more important.

• Changing the reference partner: One possibility is to end the transaction by giving notice. Another possibility is to look for another reference partner.

Experiments have shown that people who feel underpaid reduce their workload. However, overpaid test subjects very rarely increase their work effort. This can be explained by the fact that it is easier for overpaid workers to value their labor input higher than it is for underpaid workers to devalue their work performance. In addition, the experiments showed that both underpaid and overpaid workers showed lower job dissatisfaction than adequately paid workers.

Single receipts

1. ^ ^{A b} C. Shapiro, J. Stiglitz: Equilibrium unemployment as a worker discipline device. In: American Economic Review. June 1984.
2. ↑ M. Kräkel: Organization and Management. Mohr Siebeck, Tübingen 2012, pp. 97-102.
3. ↑ GA Akerlof: Gift Exchange and Efficiency Wage Theory. Four views. In: American Economic Review. Volume 74, 1984.
4. ^ GC Homans: Elementary forms of social behavior. Cologne 1968.
5. ^ RD Pritchard: Equity Theory: A Review and Critique. In: Organizational Behavior and Human Performance. Volume 4, 1969.
6. ^ MG Evans, L. Molinari: Equity, Piece-Rate Overpayment, and Job Security: Some Effects on Performance In: Journal of Applied Psychology. Volume 54, 1970.

literature

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