Efficiency Wages



What are the The Wages for Efficiency?

In economics of labor the term “efficiency wages” refers to the amount of wages that are that are paid to workers over that of the the minimum wage to ensure that they have an efficient and skilled workforce. The concept of efficiency wage suggests that employers must pay its employees a fair amount to ensure that employees are enticed to work hard and highly skilled workers don’t quit. Efficiency wages could be offered to employees in fields that require a lot of trust — such as those working in precious metals, jewelry or finance, to ensure they stay loyal.

The efficiency wage theory can help explain why companies pay more for labor. The theory argues that higher wages increase overall productivity and profits for an organization in the long term.

Understanding the Efficiency Wages

Efficiency wages were discussed 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. As an example, Smith observed that workers employed by jewelers or goldsmiths although they were often as skilled as those employed by blacksmiths, or other craftsmen were paid more each hour. 1 Smith thought that this might be because of the need to encourage these workers to avoid taking these products that are more valuable.

In more contemporary contexts efficiency wages are the fact that some employers don’t cut wages below the minimal wage even in presence of competition from rival firms or during times of recession , when a large supply of labor unemployed is available. This is unsettling for some economists who were based on the idea that business owners with a rational mindset and efficient labor markets must keep wage levels as low as they can.

The answer to this puzzle 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 the rate of employee turnover Increased wages can discourage workers from leaving. This is particularly true if recruiting and training new employees is a costly and time-consuming process.
  • Increase morale Additionally an efficiency pay raise can keep employees happy and decrease the amount of unhappy employees who could lower morale and slow production.
  • Enhance productivity Increased wages will result in more productive workers who create more goods per hour, and also put forth more effort. They also decrease shirks (being lazy at work) and decrease absences.
  • To retain and attract skilled workers Although workers who are not skilled could be seen as similar from the point of view of management high-skilled workers are usually in higher 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 lower the bottom line of the company.

Efficiency Wage Theory

While the concept of an efficiency wage has been around for a few decades, the concept was established by economists in the second half of 20th century. Examples of this include Joseph Stiglitz and his research on shirks. With fellow colleagues Stiglitz suggested that when the unemployment rate is high, those who have been dismissed are able to find new work. But, this also increases the chances that a worker will escape punishment for being unproductive or lazy (i.e., “shirk on the job”). However, as shirking can reduce the profitability of a company employers are encouraged to increase wages to stop this from happening and to motivate their employees. 2 Stiglitz received the Nobel prize in economics in 2001 in part due to his work.

George Akerlof Another Nobel prize winner, also was a researcher on the efficiency of wages, proposing the idea that wages stay ” sticky,” even during times of economic turmoil in which employers do not cut the wages that their staff members earn. Instead, to save money employers fire employees (instead of hiring more employees who earn a lower wage). But, this can increase the percentage of involuntary unemployment. The wages of workers are not defined by a market for jobs but rather the efficiency goals of companies who must hire those with the highest level of expertise. Akerlof who was working alongside Janet Yellen suggested that businesses can save on training and hiring expenses by laying off workers as the economy is struggling instead of reducing the wages of all its employees throughout the world.