The Economics Book

302

See also: Supply and demand 108–13 ■ Depressions and unemployment

15 4 – 61 ■ Market information and incentives 208–09

U

S economists Carl Shapiro

and Joseph Stiglitz contend

that firms pay what must

be more than the market wage

because there is always a core

of unemployed workers. They

explain this with the idea of

“efficiency wages.” Employers

choose to pay over the market

wage because it is worth their

while—they get more from their

employees this way.

This situation arises because of

market “imperfections.” Employers

cannot observe their workers’ effort

without cost (a problem that

economists call “moral hazard”).

Because of this, Shapiro and

Stiglitz argue that efficiency wages

cut “shirking.” If workers knew they

would be right back in a job as soon

as they got fired, they might be

tempted to slack on the job. The

higher wages and the knowledge

that dismissal might lead to long-

term unemployment increases the

cost of losing a job and will make

workers less likely to shirk.

Employers also cannot observe

their workers’ ability without cost,

and efficiency wages might help

to attract better applicants. Other

explanations include the employer’s

desire to boost morale and

minimize turnover (the higher

the wage, the easier it is to hold

on to workers and avoid costly

retraining). High wages may also

keep workers healthy enough to

do a good job. This is particularly

important in developing countries.

Efficiency wages can further

explain why firms don’t cut wages

if demand falls: if they did, their

best workers might quit. ■

BUSINESSES PAY

MORE THAN THE

MARKET WAGE

INCENTIVES AND WAGES

Workers build the Model T motorcar

on Henry Ford’s revolutionary assembly

line in 1913. One of Ford’s insights was

to realize that his own workers should

also be his best customers.

IN CONTEXT

FOCUS

Markets and firms

KEY THINKERS

Joseph Stiglitz (1943– )

Carl Shapiro (1955 – )

BEFORE

1914 During a recession

US car manufacturer Henry

Ford announces that he is

doubling the pay of his workers

to $5 a day.

1920s British economist

Alfred Marshall suggests the

idea of efficiency wages.

1938 The Fair Labor

Standards Act introduces a

minimum wage in the US.

AFTER

1984 Carl Shapiro and Joseph

Stiglitz suggest that efficiency

wages discourage shirking.

1986 US economists George

Akerlof and Janet Yellen

suggest social reasons for

paying efficiency wages, such

as boosting morale.