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The Poor Wages of ‘Efficiency-Wage’ Theory

The energy and creativity that people devote to finding reasons to justify their faith in minimum wages are astounding.

Aaron the Aaron

Dear Mr. the Aaron:

Your argument that “efficiency wage theory is evidence that raising the minimum wage is profitable for employers” suffers from several flaws.  Here are two.

First, theories are never evidence of anything.  Theories instead are stories we tell to make better sense of the evidence – better sense of the reality that we observe and experience.  Second, efficiency-wage theory is a fancy term for the rather unremarkable practice of employers’ using offers of higher wages to elicit from their workers better-quality effort over time.  Yet it does not follow that raising the wage premium always raises worker productivity by enough to justify the higher wage.  At some point the value to the employer of the next increment of increased worker productivity will be less than the cost to the employer of purchasing that increment.  And there’s no reason to suppose that profit-hungry employers have not already purchased with ‘efficiency wages’ all the increases in worker productivity that can profitably be purchased with such wages.

To assume that forced hikes in the wages of labor are always worthwhile to buyers of labor (that is, to employers) because these wage hikes prompt workers to increase the quality of their work-efforts makes no more sense than to assume that forced hikes in the prices of automobiles are always worthwhile to buyers of automobiles because these price hikes prompt automakers to increase the quality of their cars and trucks.

I encourage you to read the wise words of my colleague Alex Tabarrok on this matter, as well as those of the labor economist Don Bellante.

Donald J. Boudreaux
Professor of Economics
Martha and Nelson Getchell Chair for the Study of Free Market Capitalism at the Mercatus Center
George Mason University
Fairfax, VA 22030


Note also that a fancy name for a mundane practice is likely evidence of poor analysis.