Discuss about the Relationship Between Efficiency Wage Theory and Performance.
The paper examines the relationship between efficiency pay and performance and provide solutions that should be adopted by Australia to solve wage problems. The study focuses on the efficiency wages as well as the subjective performance in order to motivate workers in Australian labor market setting (Agell & Bennmarker, 2007). The paper deeply reveals how turnover cost can be used to determine the optimal wage contract which in most cases is the integration of subjective performance and efficiency wages. According to various studies examined, it is quite evident that when Australian labor market is experiencing high turnover costs they tend to use more subjective pay as well as less efficiency wages.
When the Australian market is experiencing such turnovers wage payment is always lower and employment equilibrium rises higher than normal. The paper is organized into two parts in which part one of the content describes efficiency wage theories and various models making it up. It further lay strong foundations on the theory implications of the theory and its models in labor market (Agell & Lundborg, 2013). The second part of the discussion analyses various empirical evidence and end with a conclusion drawn efficiency wage models and sub models.
The efficiency wage theory according to various sources indicates that the productivity of an employee in every organization is directly dependent on the provided wages. The theory further elucidates some mechanisms which provide elaborations on the relationship between efficiency wage and performance. Efficiency wage theory also provides various mechanisms known as models which explain the dependence of wages and performance. Efficiency wage theory therefore from the explanations maintains that firms in Australia should pay their employees a wage that is above normal rate prevailing in the labor market. According to the economic literature, the theory only applies in a market clearing wage where labor supply is at the normal rate with labor demand.
In such market as revealed by various economists, labor supply proceeding the normal rate leads to unemployment while excess labor demand by firms leads to labor insufficiency. According to normal economics a clearing market is at an equilibrium with natural unemployment. Since the market is at equilibrium firm owners and managers therefore apply efficiency wage theory in order to increases performance or labor productivity (Akerlof & Yellen, 2016). Application of efficiency wage theory as already mentioned in the introduction above increases worker productivity and reduces turnover.
The main idea behind efficiency wage is to increase labor productivity. The idea can be confirmed with the application of basic economics as discussed during the lessons. The relationship between efficiency wage and performance can be justified in a simple supply demand curve. As normal demand supply curve illustrates higher supply at higher prices so as the higher the wage the higher the productivity of an employee (Campbell & Kamlani, 2007). In a normal life situation, an employee of a given organization will always tend to put on more effort at higher compensation. For instance, a worker being paid a higher wage rate will work longer hours compared to a worker being paid at the normal labor market prices.
A worker which is being given a compensation higher than the normal will also put more effort and worker harder. On the other hand, an employee being given less payments will tend to work as per the pay (Campbell & Kamlani, 2007). The graph below illustrates the idea behind the higher you work the higher one gets paid. The graph has organized inform of a labor supply curve to indicate how efficiency wage relates to performance. The x axis indicates labor in hours while the Y axis indicates wage offered.
The above graph indicates the effect of price increase on the willingness an employee is willing to work. With an increase of the wage from the minimum wage of $100 to $200 for every five hours of work done, an employee is willing to add extra three hours due to the increase in the pay. It is therefore evident from the above with higher compensation a worker will work harder therefore justifying the efficiency wage theory of the higher the wage the higher the productivity or performance
The efficiency wage models give an assertion that labor productivity of employees in any given firm correlates positively with the amount of compensation they receive. This model can be explained through various theories or sub models. These theories give reasons as to why firms in Australia should continue applying the idea of efficiency wage.
The first model explaining the reason why Australian firms should adopt efficiency wage theory is the shirking model. The theory of shirking models states that when an employee is being given a wage above the normal wage he or she becomes afraid of losing the job to another person since the cost of losing a job at higher wages is high. Workers therefore at higher compensations do not shirk and risk being relieved of their duties. Higher wages as a result of acts as an incentive in this case.
Another reason why firms are advised to apply the theory of efficiency wage can be seen through the model known as the gift exchange model. In most of the occasions workers tend to view high wages as a gift from the employer firms. With this kind of perception, a higher percentage of workers show hard work as way of returning this gift to the employers. It is therefore clear that in the process of retuning the gift to the employers, the workers rate of performance increases.
Workers will also work hard when they perceive their employer as fair. When employees are paid above the normal Australian job market pay rate they tend to view higher payment in terms of fairness therefore working harder. On the other hand, when workers are paid wages under the amount they view to be fair they will the same apply less efforts at work. This model is known as fair wage effort mode relating efficiency wage performance with fairness and performance.
The relationship between efficiency wage and labor performance can also be explained through a turnover model as already mentioned (Krueger & Summers, 2008). The turnover models explain that if efficiency wage theory is adopted in Australia firms will be saved from the cost of training new workers every time. This is because if workers are paid high wages there are low chances of employees leaving one firm to another or quitting their jobs thus no need for new workers as already employed workers maintain their jobs.
Adverse selection model is another model supporting the theory of efficiency wage. This model states that when employees are compensated with a wage that’s is above the prevailing job market equilibrium wage, attention of more workers are drawn towards the firm. In other word this theory explains that efficiency wages attract diverse skills enabling the firm to select workers from available bigger pool (Nickell, 2009). This always happens when more diverse workers are drawn to the gates of the well-paying firm. The firm therefore enjoy the advantage of selecting bets workers from the bigger labor pool. It is therefore important for firms in Australia to employ efficiency wage to enjoy better performance and high labor productivity.
On the other hand, application of efficiency wage may result into several implications and consequences. Even though the efficiency wage theory has proved to have several advantages, it can also be viewed in another perspective (Layard, Nickell, & Jackman, 2015). According to a research conducted on New York City taxi drivers, it was noticed that most of them left job after the payment. This kind of behavior indicates the disadvantage of efficiency wage theory. Drawing illustrations from the taxi driver’s research in New York, it is evident that some employees may not show hard work after higher pay.
Another implication of efficiency wage theory may be seen where the rate of cost of production does not much the profit. In a case where a firm is paying wages that is higher than the economic equilibrium (Wadhwani & Wall, 2011). The higher payment is only worthy when the magnitude of employees’ productivity matches or actually higher than the cost of production. Another consequence of efficiency wage to the Australian economy may be unemployment. Application of efficiency wage always results into large labor queues at the gates of high paying firms resulting into involuntary unemployment (Nickell, 2009). Irrespective of many people looking for jobs as a result of high payment, firms tend to limit the number of employs in order to avoid accelerating cost of production. Efficiency wage therefore results into unemployment as mentioned since firms conduct rationing of employees in order to ensure that marginal cost of production is similar or higher that the productivity marginal.
Various studies have been conducted concerning efficiency wage where some criticize the theory while others support it. The main problem of efficiency wage theory is mostly as a result of methodologies or alternative models used. There are several factors which play major roles as variables in the theory models which does not make sense. It close to impossible measuring abstract notions such as fairness and gratitude. Other factors which cannot be measured in the efficiency wage models includes effort as well as asymmetry information (Wadhwani, & Wall, 2011). A lot of information concerning performance can be explained by other models better compared efficiency wage theory.
The study conducted by various writers suggest the relevancy and effectiveness various models or theories used to explain efficiency theory. According to various studies, these models may have a different meaning in the real world. These discussions in the current study have been linked to above discussed models in relations to efficiency theory.
The study conducted by George Borjas in support of shirking model conducted in a manufacturing industry in the United States of America can be criticized in the real world. The study indicated that some workers were laid off as a result of shirking. He indicated in his studies that the dismissal of workers from the company was as disciplinary action since they dismissed workers were shirking (Campbell & Kamlani, 2007). In contrary to the study of George, other studies like that of Polachek and Siebet justify that most firms are reluctant firing shirking workers.
According to the study of Agell and Lunborg which gives assertion that efforts related to work hinges on a higher rate compared to several firms’ ability lay lethal economic related penalties. The idea behind this study was supported by several readers who responded to Campbell and Kamani’s study (Akerlof & Yellen, 2016). The model therefore cannot be justified in the normal world situation and does not explain psychological integration between managers of firms and workers. Most of the respondents to the study of Campbell study suggested that most relevant gift to employers than wages is the adverse labor selection. It is difficult in the normal world for employers to incur extra cost on wages as motivation as it may bring complications with the workers’ unions.
In the real world situation, employers always deduct training cost from employees’ compensation after they are employed (Agell & Lundborg, 2013). Therefore, most of the employers will tend not lay much concern on training cost. Both literatures from the studies of Campbell and Kamlani as well as that of Agell and Lundborg provides the confirmation that most employers retain their employees based on human capital rather than training cost.
Most of the workers in the real world always view cuts laid on the salaries as unfair but not the less wage they receive. Drawing illustration from C-K it is justifiable that cut on salaries means a lot unfairness than low wages (Agell, & Bennmarker, 2007). Moreover, it is unfair for employers to give more wages compared to labor output. Viewing the situation in another perspective, the study done by Lundborg and Agell substantiate the idea of fairness in relation to firms.
Conclusion
It evident from the part to of the study that most studies lay support on efficiency wage theory application. They also tend to pin point various unclear ideas behind efficiency wage theory in relation to performance. Furthermore, various sub-models indicates various problems as most of the variables cannot be closely observed. It is therefore evident that efficiency wage theory is polycausal rather than monocausal compared to unionization. It is therefore clear that in most cases the models cannot explain the relationship between wage and performance. Drawing conclusions from the current study the Australian state policies makers should closely view the implications and consequences of efficiency wage theory. Efficiency theory models and hypotheses can be considered to be non-satisfactory since several variables used are not observable thus policy makers should not bank in the theory.
References
Agell, J., & Bennmarker, H. (2007). Wage incentives and wage rigidity: A representative view from within. labour economics, 14(3), 347-369.
Agell, J., & Lundborg, P. (2013). Survey evidence on wage rigidity and unemployment: Sweden in the 1990s. The Scandinavian Journal of Economics, 105(1), 15-30.
Akerlof, G. A., & Yellen, J. L. (2016). Efficiency wage models of the labor market. Cambridge University Press.
Campbell, C. M., & Kamlani, K. S. (2007). The reasons for wage rigidity: evidence from a survey of firms. The Quarterly Journal of Economics, 112(3), 759-789.
Clark, A. E., & Oswald, A. J. (2006). Satisfaction and comparison income. Journal of public economics, 61(3), 359-381.
Fehr, E., & Tyran, J. R. (2007). Money illusion and coordination failure. Games and Economic Behavior, 58(2), 246-268.
Krueger, A. B., & Summers, L. H. (2008). Efficiency wages and the inter-industry wage structure. Econometrica: Journal of the Econometric Society, 259-293.
Layard, P. R. G., Nickell, S. J., & Jackman, R. (2015). Unemployment: macroeconomic performance and the labour market. Oxford University Press on Demand.
Nickell, S. (2009). Product markets and labour markets. Labour Economics, 6(1), 1-20.
Wadhwani, S. B., & Wall, M. (2011). A direct test of the efficiency wage model using UK micro-data. Oxford Economic Papers, 43(4), 529-548.
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