Thursday, July 16, 2009

Efficiency Wages and Unemployment

"Economists call the theories that link productivity or the efficiency of workers to the wage they are paid efficiency wages." That definition is from Oliver Blanchard's textbook, Macroeconomics. I use that definition as a backbone for today's thoughts on unemployment.

When a firm pays an employee above market-clearing wages, I call this an efficiency wage. The wage is higher than necessary to retain the employee so the wage gives the employee an incentive to stay and be productive since there are no alternate uses of time that pay more. Employees who are paid above market-clearing prices have a higher morale. I have always said, that "Employees who feel good about themselves are more productive." What is the link between efficiency wages and unemployment?

Efficiency wages cause structural unemployment. In other words, the market does not clear because the pricing mechanism is broken. Wages can not adjust to market conditions so some workers who would contribute to the labor force find themselves out of a job at the higher wage. This is like the unemployment that results from the minimum wage.

There is evidence that workers who operate expensive machinery are typically paid an efficiency wage. I believe that these workers are highly skilled and finding a replacement for these workers are costly. Paying a higher wage than the market, will retain these workers and prevent these workers from leaving with valuable trade information.

In my opinion, when the demand for machine operators increases, the wages in for that job increase. Employers will find it profitable to substitute machines, or capital, for workers. These workers will be unemployed and will seek jobs in unskilled labor markets. Unskilled labor markets will see an increase in the supply of workers and wages fall. Thus, income disparity deepens.

Efficiency wages are one reason for structural unemployment. When economics talk about the natural rate of unemployment, they mean some structural unemployment is always present. Do you agree that structural unemployment caused by efficiency wages is healthy for the economy? If you believe the theory, productivity would be higher.

1 comment:

  1. Are you sure about the natural rate connection to the structural rate? I was under the impression that the natural rate was largely frictional. Structural unemployment, while always somewhat present, is more severe during major changes in the economy (the advent of desktops/internet, industrial revolution, etc).