Workers receive wage in return of their productive performance. In the labor market, demand and available supply of labor determine the payable wage to workers. Market equilibrium wage though indicates an efficient labor market scenario; employers however often agree to pay an above equilibrium remuneration to enhance performance of workers. When a higher wage is paid by the employers without any external force then this is called efficiency wage (Ehrenberg & Smith, 2016). Many economic theories though support the rationale of efficiency wage, there are some contradictory theories as well. The theory of backward bending labor supply curve contradicts the theory efficiency wage after a threshold level of wage.
Many studies have been conducted to analyze the wage structure in specific industries and existing differences in wage level. Productivity of workers and standard of living differ depending on their wage. Industries undergone several changes over time. With change in industry’s structure employment trend changes and so is the wage (Shields et al., 2015). Different theoretical models are developed to study the wage structure. The theories are then reasserted with reference to real world evidences.
The inequality in wage structure is explained with a model called pay for performance. The model suggests that higher wage indicates a higher incentive to work which induces workers to put greater effort. This improves performance of workers in the form of increased productivity. Skills of workers improve overtime in response to high wage (Altman, 2015). Workers ability differs within firm resulting in a wage inequality across different industries.
A proposition in favor of equality in wage distribution is made by the equitable wage theory. According to this theory poverty and income inequality increases the wage gap among workers. The theory explains wage difference for differing job profile, state of the economy and difference in firms’ structure. The equitable wage theory aims to reduce wage inequalities across nations (Sikka, 2015) The theory might be appealing from perspective of social welfare but the same is not true when viewed from an economic perspective. The scheme of equal wage eliminates incentive for extra work leaving no room for improving productive performance.
Several factors contribute to persistent unemployment in the labor market. These factors include legislation of minimum wage, people searching for new jobs and labor union bargaining. Another effective explanation of above equilibrium wage and resulted unemployment is given by the theory of efficiency wage (Dunlop & Segrave, 2016). In the economic literacy, the theory of efficiency wage focus on exclusively explaining the relation between performance and pay. The theory suggests that firms should give workers a wage higher than equilibrium wage. A higher wage increase productivity, cohesiveness in the workplace, the sense of loyalty and responsibility among the workers and reduces tendency of shirking. In contrast, wage below the market clearing wage contribute to dissatisfaction among the workers leading to a negative attitude towards work (Weiss, 2014) This hampers productivity and results in high turnover. The efficiency wage theory is again supported by difference theoretical model which are briefly discussed below
Health of workers: The simplest explanation of efficiency wage theory is improvement in health of workers. This version of efficiency wage theory shows the direct linkage between health of workers and offered wages. A high paid worker is able to afford a more nutritious diet. The healthy diet has a favorable effect on productivity of workers. Healthy and nutritious diet helps to improve workers’ health making them more productive. It is preferable for employers to pay a high wage and retain healthy group of workers instead of paying equilibrium wage that is insufficient to meet the demand of nutritious diet. The lower wage thus leave the workers to suffer from poor condition of health hampering productivity.
The explanation though sounds effective but it is not applicable for workers belonging to rich countries. In developed nations, equilibrium wage is high enough that the workers can easily afford a balanced and healthy diet. Firms in these countries do not bother at all about the fact that paying a high wage beyond the equilibrium wage would affect workers’ health in any way. This explanation rather is more relevant for poor developing countries (Stiglitz & Rosengard, 2015). In poor countries, marginal increase in wage can make a notable difference in health condition of workers. Most of the firms in Africa fears that cutting wage of the workers could have a significant adverse effect on workers’ health.
Adverse selection model: Wage is an important determinant of quality of workforce. There are no such tools that can assess workers’ quality clearly. If firms offer a higher wage, then this attract better quality and talented workers for a given job position. Lower wage on the other hand discourage better quality workers. Higher wage thus seems to be a useful way to attract talented pool of workers.
Model of worker turnover: The model suggests that higher wage increases opportunity cost of leaving the current job This in turn helps employers to retain workers for a longer period than otherwise be. The turnover model of efficiency wage indicates an opposite relation between wage and workers’ turnover in a firm. High turnover is costly for a firm because firms need to spend a lot of time and money trained newly joined workers (Zhang, 2018). It is therefore fairly reasonable for the company to pay a higher wage and retain the experienced workers.
Shirking model: Productivity of a worker depends on the work effort that workers put. Following a lower wage workers have a tendency to shirk their job responsibility. Monitoring and supervising work effort to each of workers is costly. Higher wage provides workers incentive to put higher effort (Card et al., 2018). With the fear of losing a high paid job workers reduce shirking behavior and thus support higher payment for improving performance.
The theory of labor market segmentation originated from wage discrimination practice of wages in twentieth century. Segmented labor market is characterized as a market with different sub markets each with a different condition. In real word however differences in different submarkets are not clear rather overlapping. Regional market, branch market and professional markets are the three well segmented sub markets (Alt & Iversen, 2017). The dual economy prepares the basis of labor market segmentation. The dual economy is divided into two segment – high income and low income segment.
Another two clear segmented markets are primary and secondary market. The primary labor market segment is characterized by high paying jobs with senior posts. The primary segment remains clearly distinct from that of the secondary segment. In such segmented labor market wage is used as an important tool for improving condition on workers and reducing turnover.
Several studies attempted establish relevance of efficiency wage theory with empirical evidences. Studies on Australian labor market during the period of 1980 and 1990 could not find supporting evidences. Some evidences however has been found supporting efficiency wage theory on ground of prevailing voluntary unemployment in Australia (Preston, 2018). Considerable time has been invested to find out the connection between wage and motivation of workers in public sectors. Evidences are found about significant differences in wage structure between public and private sector. Past literatures found that in public sector wage is not the only factor affecting work effort. It is motivation to the workers that influences work effort and productivity (Belle, 2013). The elasticity of work effort with respect to motivation is found to be considerable higher.
In real world many industries follow the theory of efficiency wage to boost workers’ productivity. One such example is efficiency wage paid by Henry Ford. The tradition started since 1914. Ford then offered a wage of $5, twice that of average wage of automakers during that time. The higher wage effectively increased productivity and profitability of the company. The increased wage paid by Ford raised competitive pressure on competitors. In an attempt to increase wage many automobile companies went bankrupt. The company considered higher wage as an effective wage to retain high quality work. Ford again revised the wage to $6.00 per day (Cobb, 2016). The trend of high wage continued till today and workers in Ford receive a considerably high wage.
The theory of efficiency wage is often criticized on the ground that labor supply does not increase indefinitely with increase in wage. Supply initially increases with wage but only up to a certain point (Sharif, 2018). After the critical level, workers prefer leisure hours to the work effort and labor supply starts to decline questioning the theory of efficiency wage.
The backward bending labor supply curve is a graphical tool indicating real world relation between wage and work effort. Increase in wage after a certain limit labors starts substituting work hours with leisure. This shows that higher wage lead to a decline in supply of labor. The can be explained in detail with labor leisure trade off. The basis of the trade-off is the comparison between received wage for each working hour and the satisfaction enjoyed during unpaid time (Weiss 2014). After a certain limit labors prefer leisure hours more to work effort and reduces labor supply causing the labor supply curve to bend backward after the threshold limit.
Conclusion
Fair Work Commission should consider all the theories and evidences related to employment and wage. It is beneficial for the company to offer a higher wage if and only if it improves performance of workers. Following Henry Ford’s experience, it can opt the strategy of paying a higher wage. Additionally, the company should consider resulted increase in production cost from higher wage. The final wage should be set at a level that is beneficial for increasing workers’ productivity with cost remaining under control.
References
Alt, J., & Iversen, T. (2017). Inequality, labor market segmentation, and preferences for redistribution. American Journal of Political Science, 61(1), 21-36.
Altman, M. (2015). Cooperative organizations as an engine of equitable rural economic development. Journal of Co-operative Organization and Management, 3(1), 14-23.
Belle, N. (2013). Experimental evidence on the relationship between public service motivation and job performance. Public Administration Review, 73(1), 143-153.
Card, D., Cardoso, A. R., Heining, J., & Kline, P. (2018). Firms and labor market inequality: Evidence and some theory. Journal of Labor Economics, 36(S1), S13-S70.
Cobb, J. A. (2016). How firms shape income inequality: A rejoinder to Zardkoohi and Bierman. Academy of Management Review, 41(4), 749-754.
Dunlop, J., & Segrave, M. (2016). The theory of wage determination. Springer.
Ehrenberg, R. G., & Smith, R. S. (2016). Modern labor economics: Theory and public policy. Routledge.
Preston, A. (2018). The structure and determinants of wage relativities: evidence from Australia. Routledge.
Sharif, M. (2018). Work Behavior of the World’s Poor: Theory, Evidence and Policy: Theory, Evidence and Policy. Routledge.
Shields, J., Brown, M., Kaine, S., Dolle-Samuel, C., North-Samardzic, A., McLean, P., … & Plimmer, G. (2015). Managing employee performance & reward: Concepts, practices, strategies. Cambridge University Press.
Sikka, P. (2015). The hand of accounting and accountancy firms in deepening income and wealth inequalities and the economic crisis: some evidence. Critical Perspectives on Accounting, 30, 46-62.
Stiglitz, J. E., & Rosengard, J. K. (2015). Economics of the public sector: Fourth international student edition. WW Norton & Company.
Weiss, A. (2014). Efficiency wages: Models of unemployment, layoffs, and wage dispersion (Vol. 1192). Princeton University Press.
Zhang, W. B. (2018). Economic Growth Theory: Capital, Knowledge, and Economic Stuctures. Routledge.
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