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Efficiency Wage Theories: A Partial Evaluation

This paper surveys recent developments in the literature on efficiency wage theories of unemployment. Efficiency wage models have in common the property that in equilibrium firms may find it profitable to pay wages in excess of market clearing. High wages can help reduce turnover, elicit worker effort, prevent worker collective action, and attract higher-quality employees. Simple versions of efficiency wage models can explain normal involuntary unemployment, segmented labor markets, and wage differentials across firms and industries for workers with similar productive characteristics. However, deferred payment schemes can solve some efficiency wage problems without requiring job rationing. A wide variety of evidence on interindustry wage differences is analyzed. Efficiency wage models appear useful in explaining the observed pattern of wage differentials. The models also provide several mechanisms for cyclical fluctuations in response to aggregate demand shocks.