Abstract
Firms may pay efficiency wages to enhance productivity. The conventional presumption is that efficiency wages are inefficiently high because they lead to unemployment that is also inefficiently high; government policies that lower wages raise output. Using a simple and general efficiency wage model, this paper finds a necessary and sufficient condition for the opposite conclusion. If the condition holds, wages are inefficiently low, leading to productivity that is also inefficiently low. It is the high-wage policies that raise output, even if they also lower employment. Published empirical results support the condition. No evidence is found for the conventional presumption.
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