Efficiency Wages: A Double-Edged Sword

Why paying less (sometimes) buys you more

I.

Suppose you’re an employer trying to hire for an important position. Maybe your organization is (or seems) socially beneficial, so some people genuinely care about your mission, or maybe the role is quite enjoyable for some. Either way, the position provides potential employees something they care significantly about beyond the pay.

Still, no one is going to do it for free, and you have to decide how much compensation to offer. The naive, Econ 101-strawman thing to do is to choose the salary that will just barely attract one qualified person to fill the role.

But, obviously, “qualified” is doing a lot of work here. There’s a reason that real firms interview dozens of candidates for a single slot, even though they could save money and make hiring easier by offering less. Namely, higher wages attract more qualified and experienced candidates, increase employee satisfaction (and thus productivity), and decrease turnover. In general, above-market-clearing wages offered for these reasons are known as “efficiency wages.”

II

At first glance, it seems that higher wages attract better candidates, who in turn make for better employees. In general, I think this is correct. However, employers face the timeless challenge of selecting from a pool of candidates with only a few pieces of information about each, none of which are exceptionally indicative of future job performance. Attracting more candidates isn’t always a good (or even neutral) thing - you might accidentally hire someone who performs worse than his resume and interview indicated.

Basically everyone cares about money, but not everyone cares to the same degree. So, offering a nicer salary will attract better candidates, but it will also attract candidates who generally care more about money relative to the intrinsic value of the job itself - whether contributing to a mission they care about or having fun at work.

When placing high relative value on the position itself is a strong, positive indicator of future job performance, offering more money can make for worse hiring decisions. Likewise, even when the net effect of offering more money is positive, it might be less beneficial than you’d first expect.

A few examples

Public defenders

Public defenders make an average of about $61,000 annually. Not nothing, but far less than the ~$120,000 among lawyers at large cited even by this very pessimistic article. Public defending is notoriously demanding and time-consuming as well, so the discrepancy is unlikely to reflect more pleasant work.

So, are public defenders the runts of the legal profession - those unable to secure more lucrative positions? I doubt it. The position is considered noble and praiseworthy, even among laypeople like myself. I am quite confident that its function as a barrier, however insufficient, between the poor and mass incarceration at least partially motivates many who serve.

But my point is not merely that states get away with paying public defenders so little. Holding salary constant, there is probably a correlation between being one’s willingness to forego monetary compensation for the greater good and the skill and effort one will dedicate to the work itself.

In other words, public defenders will probably tend to be better and harder-working than the typical lawyer who gets paid $61,000 to do what is perceived as morally-neutral work. A lawyer who chooses to become a public defender must (generally) want to actually do the job well. If not, why forego a higher salary in the first place?

To be clear, I am not claiming that states should maintain the salaries of public defenders. Pay should increase, both because the attorneys deserve greater remuneration and because (I’d guess) that the talent-attracting power of greater pay would more than compensate for the benefit provided by this correlation. However, this effect likely somewhat offsets what a more standard model would predict.

Facebook

I said that “basically everyone” likes money, but a solid everyone hates Facebook. Whether you care most about its hosting of far-right misinformation, dragging millions into hours of mindless newsfeed scrolling, or facilitating a genocide in Myanmar, it’s probably not high on your ethical all star list.

Software engineers and data scientists are no different, and most would probably prefer not to work for a firm they think to be bad for the world. More cynically, maybe some just don’t like the social stigma associated with their employer, especially after the release of the documentary linked above.

Either way, most of these folks probably need pretty decent monetary compensation in return. Indeed, it’s safe to say that the data scientists making well over $100k, and sometimes close to $400k in total compensation are doing okay. (As an aside, I honestly don’t blame any sub-management employee for the harms I’ve described, and think that any employee could easily compensate for her individual impact by donating a bit of her salary to fight malaria or something).

It’s just the opposite of the public defender case above; by paying more in compensation, Facebook is attracting a lower proportion of applicants who genuinely care about the company, or who find their work fascinating and delightful. Once again, it’s not that they’d do better by paying less. It’s just that paying less might not be as bad as straightforward economic modeling would suggest.


The unifying principle is this: paying less means that the candidates you attract are more likely to be motivated by the firm or the work itself, and therefore tend to be better at what they do.

A Distinction

There’s nothing original in the claim that firms can pay less for desirable work and have to pay more for unpleasant work. This principle, however, would exist even in a market with perfect information - that is, even if employers could predict exactly how well each prospective employee would perform.

What I’m describing though, is a product of employers’ lack of information about each job candidate. Applying for a job despite relatively low pay is a credible signal that a candidate intrinsically values the work itself. This is information that is difficult to convey on a resume, and is easily faked in an interview or on a cover letter.

So, should anyone actually reduce pay to get better workers?

Well, maybe, but probably not. Like the theoretically-possible-but-probably-nonexistent “Giffen good,” I think that the competence-signalling effect of “reverse efficiency wages” almost always mitigates but does not overcome the disincentive effect of lower pay.

But, here are some conditions in which I’d expect this phenomenon to have a large positive effect relative to the negative disincentive effect:

  • High baseline pay (since it requires that a worker “indulge” his moral beliefs and personal preferences, I’m guessing it’s stronger when he or she has more financial flexibility).

  • It is difficult to ascertain future job performance from standard indicators like resume, college transcript, and interview.

  • Performance is a strong positive function of effort and/or desire to do the job well.

  • Hiring and firing are relatively difficult, slow, and/or expensive (increasing the value of credible signals of future performance).

  • The position is morally or personally appealing for some but not all applicants.

To be honest, I have a hard time thinking of a stronger case than of public defenders: lawyers make a lot of money, it’s difficult to measure performance, effort seems likely to boost performance, and only part of the population thinks trying to keep poor people out of jail is a good thing to do.

What other professions might be similar? Many in the public sector, I suspect: teachers and social workers, perhaps. Demanding nonprofit work as well: Doctors Without Borders fieldworkers make less than $25,000 a year, and that’s for demanding work overseas. It looks like that’s for physicians, who have a median salary of over $200,000. No one does takes such an offer without strong motivation to serve the public good.

Volunteering-Lite

I think the Doctors Without Borders case illustrates a general point: volunteering takes this “reverse efficiency wage” to its extreme; even with its resume-building and social acclaim benefits, the intrinsic value of volunteer work is likely volunteers’ main form of “compensation.” With an insane 1:8 ratio between compensation and physicians’ median pay, it might be more fair to characterize DWB field work as half “work” and half volunteerism.

Even among those Machiavellian enough to do spend dozens of hours volunteering primarily as a means of getting “Eagle Scout” on their resume (yes, that’s a joke about myself), one often has some latitude in choosing particular projects, so will pick those one he thinks most socially beneficial and enjoyable. So, volunteers’ lack of pay is a quite important, credible signal that they will try to do their job well.

I think most people have a pretty intuitive grasp of this phenomenon as it applies to volunteer work; in the world of salaries and full-time jobs, “reverse efficiency wages” are a sort of volunteering-lite. The same phenomena are at play for underpaid public defenders and unpaid food-pantry-stockers alike.