Wage Change and the Quit Behavior of Workers: Implications for Efficiency Wage Theory

Abstract

Over the past decade, economists have developed efficiency wage models to explain the presence of wage rigidity and thus of involuntary unemployment. In these models, workers' productivity depends positively on the wage or firms' costs depend negatively on the wage, giving firms an incentive to pay wages above the market-clearing level. One type of efficiency wage model is the turnover cost model of Stiglitz [26], Schlicht [24], and Salop [23], in which fewer workers quit at a firm paying high wages. Since hiring and training new workers is costly, firms pay high wages to reduce the number of workers who quit. In the turnover cost model, quits depend on the level of the wage. This study argues that quits also depend on the change in the wage as well as on its level. Note that a worker's current wage is determined by his initial wage and by the amount the wage changes over his tenure at the firm. A model is developed in section II demonstrating that, under reasonable conditions, a rise in a worker's current wage not matched by a rise in his starting wage will reduce quits to a greater extent than will an equal rise in the worker's current and starting wages. This means that the change in the wage has a negative effect on the quit rate, even controlling for the current level of the wage. In fact, it is possible that quits are more affected by the change in the wage than by the current level of the wage. The hypothesis that quits depend on the change in the wage has some interesting implications for efficiency wage theory. In section III it is argued that if quits depend on the change in the wage, efficiency wage theory may be able to explain why the economy tends to return to a fixed natural rate of unemployment in mild recessions but not in times of severe recessions such as experienced by the United States in the 1930s and by Europe in the 1980s, why wages are rigid upward as well as downward, why wage rigidity varies across industries and occupations, and why nominal wage cuts are so rare.