Efficiency Wages

The theory that paying above the market clearing wage can raise productivity enough to pay for itself.

Overview

Higher pay can reduce costly turnover, attract better applicants, raise effort because workers have more to lose if fired, and improve morale and loyalty. Economists such as Carl Shapiro and Joseph Stiglitz formalized the shirking version in the 1980s, and George Akerlof developed a gift exchange version. The theory also offers an explanation for persistent involuntary unemployment, since wages do not fall to clear the market. Ford's five dollar day is the textbook historical example, and modern retailers raising starting pay to cut quit rates echo the same logic.