An Empirical Test of the Efficiency Wage Hypothesis

Abstract

The efficiency wage hypothesis is a popular explanation of observed labour market realities, however empirical testing has been very inadequate. Measuring effort and calculating productivity has been almost impossible in modern team oriented production processes. Because this study obtains a unique data set with similar production lines making the same product, across multiple geographies, but paying different wage premiums a reasonably controlled test can be conducted on the impact of wage premiums. Despite very good fitting of various production functions no statistical support is found for the idea that premium wages influence output. While these results may be somewhat surprising, given the popularity of the efficiency wage shirking model, there are possible alternative explanations discussed in this paper. As shown in this case study there is not always a connection between wage premium and output, therefore, managers should be careful about using wage premiums to increase effort and employee production.