studies of output-based pay have highlighted several problems: where performance
is diYcult to specify, notions of acceptable behavior may be targeted instead;
subjectivity in the appraisal process may lead to favoritism and bias; emphasis on
easily quantiWable outputs may lead to a decline in quality; emphasis on material
incentives may conXict with other norms of job satisfaction or work ethos; and
payments may be skewed because of their link with overallWrm performance
(Grimshaw 2000 ; Marsden and Richardson 1994 ; Rubery 1995 ). Such studies
suggest those HRM policies that do focus on problems at ‘the margin’ can do
severe damage by alienating the many workers for whom rational behavior does
not solely involve self-interested maximization.
While incentive theory is at the heart of the personnel economics approach,
other tricks from the economists’ toolbox are also routinely applied to HRM issues.
For example, the Cobb–Douglas production function (whereWrm output depends
on a quantiWable matrix of inputs, including capital and labor) is applied to
calculate, using information on wage rates and productivity levels, the optimum
mix of high-skill and low-skill workers such that, in equlibirium, the ratios of
respective salaries and outputs deliver the maximum output (Lazear 1998 ). The
modeling can be adapted for diVerences in work organization, including situations
where each worker’s output is independent of others, as well as situations where
there is interdependency—with the output of skilled workers shaping that of
unskilled workers, or vice versa—or where worker output is contingent upon the
level and quality of capital. One problem is the assumption that data on the output
eVects of teamworking and worker–capital complementarities can be easily col-
lected. Moreover, the skill mix is taken to determine output, holding all other
factors constant. But many studies in HRM, from the Hawthorne experiments to
the recent studies of high-commitment work systems (HCWSs), indicate that
HRM policies themselves may have an impact on output (Huselid 1995 ; MacDuYe
1995 ). This is consistent with economists’ notion of ‘eYciency wages’ where the
wage paid inXuences output through promoting eVort. Cross-national compara-
tive studies also highlight the role of institutions such as training systems in
shaping skill mix, systems of work organization, and utilization of technology, all
of which interact to impact upon output levels (Steedman and Wagner 1989 ;
Mason 2000 ).
Another applied economists’ trick is the use of transaction costs to prescribe
when aWrm ought to outsource or internalize a business activity. For Lazear, the
outsourcing decision depends upon a balancing of data on a subcontractorWrm’s
risk of changing business conditions to the worker, despite the fact thatWrms are better able to bear
risk (since they can diversify risk by pooling across projects or spreading investments acrossWnancial
markets). And this risk is especially diYcult for low wage workers for whom variations in income
impact upon their ability to pay for basic needs (food, housing, clothing). But, it is argued, the
personnel economist must balance this against the fact that eVort is typically easier to observe among
those with less complex tasks, making output based pay an eYcient choice (Lazear 1998 :119 20).
economics and hrm 75