Efficiency Wage and Pay for Performance Schemes

This assignment delves into the concepts of Efficiency Wage and Pay for Performance schemes as strategies to enhance employee productivity and firm success. It examines theoretical models behind these schemes, analyzing their potential impacts on worker motivation, job retention, and overall economic outcomes. The discussion also considers the complexities of implementing these schemes in real-world scenarios, taking into account labor market dynamics and external economic factors.

Running head: HUMAN RESOURCE ECONOMICS
Human Resource Economics
Name of the Student
Name of the University
Author Note

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Table of Contents
Introduction......................................................................................................................................2
Literature Review............................................................................................................................3
Equitable distribution of wage theory..........................................................................................4
Wage inequality and Efficiency Wage Theory............................................................................4
Pay for Performance Theory........................................................................................................5
Efficiency Wage Model...............................................................................................................5
Arguments in favor of Efficiency Wage......................................................................................5
Efficiency Wage and Motivation of the workers.........................................................................6
Backward Bending Labor Supply Curve.....................................................................................7
Empirical Support: Case Study of the Australian Economy.......................................................8
Conclusion.......................................................................................................................................9
Reference.......................................................................................................................................12

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Introduction
In the contemporary global scenario, employment is one of the issues of primary concern,
as much of the welfare of the people and their life style depends on the condition of employment
prevailing in the economy, which in turn also reflects the overall health of the economy of the
country. With the changes in the overall economic structure in the international framework and
in the global demographics, the employment sector has also undergone huge dynamics as the
employment structure and has changed substantially. Therefore, it becomes important to look
into the driving factors of the employment sector in an economy in general. Wage and wage
structure of an economy and the policies prevailing regarding the wage regulation in the
concerned economy, pose as one of the primary factors, which determine the overall dynamics in
the employment sector. This is because much of the behavior of the workers and their
willingness to stick to a job or to leave the same depend on the wage structure under the domain
of which these workers fall.
Wage is one of the primary factors, not only in deciding the behavior of the workers and
their overall well being but also in determining the conditions of the enterprises in which they are
employed and the overall economic structure of a country. This is mainly because the wage
structure of a company determines how well the relationship between the employees and the
employer is, which in turn plays a key role in determining the health and the long run prospects
and profitability of the company. In this context, the report studies the literatures and scholarly
works present regarding this issue of concern of wage structure and the effectiveness of
Efficiency Wages, taking into account the economic theory behind the same and the implications

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on the overall performance of the employees, with the newly implemented concept of pay for
performance being considered.
One of the earliest and still persisting school of thoughts regarding wage structure is the
Equitable Wage Theory, according to which, there should remain uniformity in distribution of
wages, which in turn increases the overall welfare of the people in a society. However, this
theory is heavily criticized on efficiency grounds, as according to this theory, the productivity
based payment structure provides more incentives for workers, thereby increasing their
efficiency and willingness to work, which is not supported by the former theory.
The economic notion of Efficiency Wage Model is relevant to the above discussed pay
for performance model as it suggests that keeping the wage a little above the equilibrium level
increases the productivity of the workers, thereby increasing the overall benefit of the firms.
There are, however, several debates regarding the credibility of the Efficiency Wage theory and
the pay for performance concept and regarding to what extent these theories can be applied in
reality. This is because of the presence of the concept of backward bending labor supply curve,
which shows the tradeoff between wage and leisure hours.
The economic notions of the Efficiency Wage Theory, the backward bending supply
curve, the notion of pay for performance in contemporary employment scenario and the
implications of all these on the employment dynamics in the global scenario, have robust literary
evidences, which will be taken into account in the following section of the report.
Literature Review
As discussed above, with time the wage structure has changed in an overall basis as well
as with respect to different geographical locations, which in its turn have immense implications

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on the overall growth and well-being of the regions and their residents. There have evolved
several theories and notions regarding the wage structures which should prevail in the economies
and their pros and cons, which try to analyze the same from different perspectives.
Equitable distribution of wage theory
One of the pioneers in the wage distribution mechanism is the theory of equitable
distribution of wage. As has been discussed in the literary works of Onaran and Galanis (2013),
the concerning issues of poverty in the world have their roots in the inequality in the distribution
of wages among the different sectors of the society. These inequalities, mainly arising due to the
difference in the nature of jobs and skills of the workers, can be reduced, as per the authors, by
implementing a more equitable wage distribution in the economy.
However, this theory, as proposed by the authors, has been severely criticized by another
school of thought, which points out towards the lack of efficiency in the equitable wage
distribution. This notion, supported by many economists and strategy planners, advocates the
presence of fair inequalities of distribution of wages, which may increase the efficiency of the
overall employment scenario and productivity of the economy.
Wage inequality and Efficiency Wage Theory
The views of Mueller, Ouimet and Simintzi (2015), oppose the views of equitable wage,
by asserting the fact that equitable wage theory, though sounds normatively appealing, is
practically not that applicable and there are reasons behind the presence of inequality in wages,
to some extent. The inequality, as discussed by the author, is often intentionally kept in the firms,
to encourage higher performance of the workers by paying higher for better performance. This,

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in turn, may be beneficial for the firms as better productivity of the workers and a more loyal
workforce can actually increase the long-term prospects of the firms.
Pay for Performance Theory
Shields et al. (2015), argues in this context, in favor of the presence of ethical inequality
in the pay structure, which points towards the feasibility of the pay for performance model.
According to this notion, the model increase the willingness to work among the workers by
providing them proper incentives and thereby increasing the productivity and the efficiency of
the workers in particular and the company in general in the long run. Many other contemporary
economists, who assert that pay for performance motivates the workers by providing financial
incentives and make them willing to sacrifice their leisure to gain more monetary benefits by
working more, support this view.
Efficiency Wage Model
The Efficiency Wage Theory, as is suggested by DiGabriele and Ojo (2017) supports the
pay for performance model. According to this theory, if the wage in an economy is kept above
the equilibrium level, to some extent, even when excess supply of labor is present in the
economy, can be beneficial for the economy. However, the presence of this higher wage can lead
to unemployment in the economy, combining with the presence of minimum wage system and
labor unions in the economies in the contemporary global scenario. However, the efficiency
wage theory is different because unlike the other two phenomena, this does not require any
regulation from the government (Schmitt 2013).

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Arguments in favor of Efficiency Wage
Workers’ Turnover - Weiss (2014) shows a direct relation between the wage structure and the
turnover rates in the professional domain of the economy in general. Turnovers are generally
higher in those firms and industries where the workers feel de-motivated due to the lack of
monetary incentives and performance based payments. In this context, as suggested by the
author, it is better to implement the efficiency wage, which may have positive implications on
the company, by reducing the turnover rates of the workers in the same.
Workers’ Health and Overall Well Being- Linde Leonard, Stanley and Doucouliagos (2014),
draw a direct relation of efficiency wage and the health and welfare aspects of the workers and
overall well being of the health of the economy of the country. Efficiency Wage, if implemented
correctly, can increase the purchasing power of the workers, thereby increasing their scope of
availing health care, which may positively affect their productivity, as healthy workers are
supposed to be more productive.
Shirking- Wages of the workers are also expected to have connections with the efforts which
they give in their job (Kwon 2014). There are several jobs in which the workers have the options
to decide how much productive they want to me. In these jobs, if pay for performance is
implemented properly, the workers will feel more motivated to work and this may in turn reduce
the problem of shirking, which is one of the most common problems in these kinds of jobs.
Efficiency Wage and Motivation of the workers
Fabris (2013) show the relation between efficiency wage and the motivational aspects in
the workplace, in his working paper, with the help of a simple mathematical function. The author
draws the effort function of the workers as follows:

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Ei = f(Wi/We, U)
[We = Equilibrium wage, Wi = Wage received in the particular firm, U = Unemployment level
in the economy]
Here, the relative wage is therefore given by Wi/We, which if higher, motivates the
workers in the same firm to work more, according to the author in this context.
All the above discussed notions in favor of the practicality of the Efficiency Wage,
advocates the implementation of the same. However, to what extent this should be implemented
is a matter of concern due to the presence of countering assertions like the theory of the
backward bending supply curve of labor.
Backward Bending Labor Supply Curve
Many economists, including Keeley (2013), point out that with the increase in the level of
wages, though initially workers tend to work more, however, after some time, when the rate of
wage is sufficiently high, the workers tend to substitute higher labor hours with leisure. This is
because they become satisfied with the level of wage they are receiving and do not want to
increase working even at higher wages. Leisure becomes more demanding then (Thuy and
Flaaten 2013). This results in a backward bending supply curve of labor, which is shown in the
following figure:

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Figure 1: Backward Bending Labor Supply Curve
(Source: Mankiw 2014)
The above figure shows that until W1, the workers go on increasing their labor hours in
order to earn more money. However, after W1 is reached, the workers do not run behind
increased wage anymore and they tend to be well off enough to afford to decrease their labor
hours and increase the amount of leisure they want to enjoy. Thus, the backward bending supply
curve theory of labor suggests that Efficiency Wage may not always work efficiently and it is
required to regulate the extent till which this policy is implemented (Leigh and Blakely 2016).
Empirical Support: Case Study of the Australian Economy
The theories of the pay for performance model, the Efficiency Wage and the backward
bending labor supply, though sounds highly practical and applicable apparently, need to be

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supported by the empirical findings in order to be considered to be practically applicable in the
real case scenario. Keeping this in consideration, the primary question, which has to be
addressed, with respect to the economy of Australia, is whether there exists a relation between
the wage and productivity and the wage and unemployment scenarios in the concerned economy
(Torry 2013).
The Efficiency Wage theory does not get much support in the trends of unemployment in
the Australian economy (McLachlan 2013). There are other important factors in the economy,
like those of the business cycle dynamics and external phenomena, which may also affect the
unemployment rates of an economy significantly and can be more prominent than that due to the
increase in the wage rates in the economy. Perry (2014), takes different countries including
Australia into account to show that the wage elasticity is 0.21 whereas the elasticity with respect
to motivation is as high as 0.61, in the public sector, which implies that workers tend to get more
inspired to work harder when motivated than when they get a hiked salary.
Conclusion
The Efficiency Wage Theory, as discussed above, does hold immense significance in the
contemporary economy and there remains a huge scope of studying the implications and
practicality of the theory in the real life scenario. This is because there are both positive as well
as negative aspects of the implementations of the Efficiency Wage and Pay for Performance
schemes, which may also generate different types of results in different economies, depending
upon the external factors under the domain of economy. The motivation factor plays a significant
role in the workplace scenario along with the wage hike. However, the presence of the labor

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supply curve of labor in the economy makes it important to regulate and properly implement the
Efficiency Wage Model in the economy in real case scenarios.

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Reference
Criscuolo, Chiara, Peter N. Gal, and Carlo Menon. "The dynamics of employment growth."
(2014).
DiGabriele, Jim, and Marianne Ojo. "The efficiency wage hypothesis and the role of corporate
governance in firm performance." (2017).
Keeley, Michael C. Labor supply and public policy: A critical review. Elsevier, 2013.
Kwon, Hyun Soo. "Economic theories of low-wage work." Journal of Human Behavior in the
Social Environment 24, no. 1 (2014): 61-70.
Leigh, Nancey Green, and Edward J. Blakely. Planning local economic development: Theory
and practice. Sage Publications, 2016.
Linde Leonard, Megan, T. D. Stanley, and Hristos Doucouliagos. "Does the UK minimum wage
reduce employment? A meta‐regression analysis." British Journal of Industrial Relations 52, no.
3 (2014): 499-520.
Mankiw, N. Gregory. Principles of macroeconomics. Cengage Learning, 2014.
McLachlan, Rosalie. "Deep and Persistent Disadvantage in Australia-Productivity Commission
Staff Working Paper." (2013).
Mueller, Holger M., Paige P. Ouimet, and Elena Simintzi. Wage inequality and firm growth. No.
w20876. National Bureau of Economic Research, 2015.

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Onaran, Özlem, and Giorgos Galanis. "Is aggregate demand wage-led or profit-led? A global
model." Wage-led Growth: An Equitable Strategy for Economic Recovery, Basingstoke, UK:
Palgrave Macmillan (2013): 71-99.
Perry, James L. "The motivational bases of public service: foundations for a third wave of
research." Asia Pacific Journal of Public Administration 36, no. 1 (2014): 34-47.
Schmitt, John. "Why does the minimum wage have no discernible effect on
employment?." Center for Economic and Policy Research 22 (2013): 1-28.
Shields, John, Michelle Brown, Sarah Kaine, Catherine Dolle-Samuel, Andrea North-Samardzic,
Peter McLean, Robyn Johns, Patrick O'Leary, Jack Robinson, and Geoff Plimmer. Managing
Employee Performance & Reward: Concepts, Practices, Strategies. Cambridge University Press,
2015.
Thuy, Pham Thi Thanh, and Ola Flaaten. "The backward-bending supply curve in fisheries-
revisited." Journal of Sustainable Development 6, no. 6 (2013): 15.
Torry, Malcolm. Money for everyone. Policy Press, 2013.
Weiss, Andrew. Efficiency wages: Models of unemployment, layoffs, and wage dispersion.
Princeton University Press, 2014.