Efficiency Wages: Employment versus Welfare

Abstract

This paper analyzes the effects of government policies in an efficiency wage model. In such a model, wages exceed market clearing rates. Firms may pay high wages for many reasons; Levine gives thirteen motivations for efficiency wages [12].' In the model used here, high wages prevent shirking by workers. The model is similar to those of Shapiro and Stiglitz, Sparks, Fairris and Alston, and others [15; 17; 7]. Efficiency wage models are often viewed as providing the microeconomic foundations of involuntary unemployment and Keynesian economics [1; 2]. Unemployment is also emphasized in many discussions of government policies [3; 4; 11]. A major example is that of Johnson and Layard [9]. They find that a per capita employment subsidy financed by an ad valorem wage-rate tax would reduce unemployment. They conclude that this policy would benefit a country because of the employment effect.2 Yet, this paper shows that the employment effect is misleading. Here, a policy that causes employment to rise (fall) also must cause income net of effort to fall (rise). So, total welfare falls (rises). The policy implications discussed by Johnson and Layard and others are therefore reversed.