Efficiency wages: Encyclopedia II - Efficiency wages - Shirking

Efficiency wages - Shirking

The shirking model begins with the fact that complete contracts rarely (or never) exist in the real world. This implies that both parties to the contract have some discretion, but frequently, due to monitoring problems, it is the employee’s side of the bargain which is subject to the most discretion. (Methods such as piece rates are often impracticable because monitoring is too costly or inaccurate; or they may be based on measures too imperfectly verifiable by workers, creating a moral hazard problem on the employer’s side.) Thus the payment of a wage in excess of market-clearing may provide employees with cost-effective incentives to work rather than shirk.

In the simplest shirking model (Shapiro and Stiglitz 1984), workers either work or shirk, and if they shirk they have a certain probability of being caught, with the penalty of being fired. Equilibrium then entails unemployment, because in order to create an opportunity cost to shirking, firms try to raise their wages above the market average (so that sacked workers face a probabalistic loss). But not all firms can have higher wages than average, and the result is that wages are raised above market-clearing, creating involuntary unemployment. This creates a low-income alternative which makes job loss costly, and serves as a worker discipline device. Unemployed workers cannot bid for jobs by offering to work at lower wages, since if hired, it would be in the worker’s interest to shirk on the job, and he has no credible way of promising not to do so. Shapiro and Stiglitz and point out that their assumption that workers are identical (eg there is no stigma to having been fired) is a strong one – in practice reputation can work as an additional disciplining device.

The shirking model does not predict (counterfactually) that the bulk of the unemployed at any one time are those who are fired for shirking, because if the threat associated with being fired is effective, little or no shirking and sacking will occur. Instead the unemployed will consist of a (rotating) pool of individuals who have quit for personal reasons, are new entrants to the labour market, or who have been laid off for other reasons. Pareto optimality, with costly monitoring, will entail some unemployment, since unemployment plays a socially valuable role in creating work incentives. But the equilibrium unemployment rate will not be Pareto optimal, since firms do no take into account the social cost of the unemployment they help to create.

One criticism of this and other flavours of the efficiency wage hypothesis is that more sophisticated employment contracts can under certain conditions reduce or eliminate involuntary unemployment. Lazear (1979, 1981) demonstrates the use of seniority wages to solve the incentive problem, where initially workers are paid less than their marginal productivity, and as they work effectively over time within the firm, earnings increase until they exceed marginal productivity. The upward tilt in the age-earnings profile here provides the incentive to avoid shirking, and the present value of wages can fall to the market-clearing level, eliminating involuntary unemployment. Lazear and Moore (1984) find that the slope of earnings profiles is significantly affected by incentives.

However, a significant criticism of the criticism is that moral hazard would be shifted to employers, since they are responsible for monitoring the worker’s effort. Obvious incentives would exist for firms to declare shirking when it has not taken place. In the Lazear model, firms have obvious incentives to fire older workers (paid above marginal product) and hire new cheaper workers, creating a credibility problem. The seriousness of this employer moral hazard depends on the extent to which effort can be monitored by outside auditors, so that firms cannot cheat, although reputation effects (eg Lazear 1981) may be able to do the same job.

Adapted from the Wikipedia article "Shirking", under the G.N U Free Docmentation License. Please also see http://en.wikipedia.org/wiki