An Empirical Test of Efficiency Wage Theory

By Janet Spitz
1989| Working Paper No. 1053

Efficiency wage theorists explicitly recognize effort as a component of labor productivity. Where monitoring is costly or difficult, incentives to work are thought to be provided by higher than market clearing wages, unemployment, or both. Higher wages attract better or more productive workers from a higher labor pool under the adverse selection hypothesis, assuming a correlation between productivity and reservation wage; these workers carry an internal incentive to perform well. External incentive is provided by unemployment in the shirking threat model, which notes that when wages clear the market and employment is full there is no cost to job loss; unemployment provides an incentive for workers to exert effort and refrain from malfeasance on the job. Employers recognize and respond to these labor supply conditions by paying a higher than market clearing wage, the wage at which the elasticity of worker effort with respect to the wage is unity: this is the low-cost, or efficient wage. The theory thus has two parts: a labor supply condition where wages or unemployment affect workers supply (of effort, if not hours), and an employer response in terms of minimization of labor costs. The two parts of efficiency wage theory provide an account for rigid wages, involuntary unemployment, or both. This paper tests the first component of efficiency wage theory, the condition of labor supply. Data is used from a work situation where employees influence the pace of their work, a chain of unionized supermarkets in nothern California. Diverse locales in the sample contain varying levels of prevailing wages and unemployment. The main result is that little support was found for the predictions of labor supply: neither unemployment nor the relative level of the wage influenced worker productivity, store performance or turnover in this sample of modern grocery stores.