Monday, June 7, 2010

Efficiency Wage Theory in Action

Apple and HP are raising wages dramatically in China in response to a series of recent worker suicides. The hope is, of course, that higher wages make happier and less hopeless workers, and therefore more productive workers.

This is the phenomenon highlighted by Efficiency Wages Theory. There are several versions of efficiency wages. Stiglitz and Shapiro talk specifically about efficiency wages as a disciplinary device in developing countries against shirking. By paying above the competititve wage, firms ensure that their workers don't shirk on the work because the cost of being fired is raised by higher than competitive wages. This is supposed to be especially relevant to jobs where monitoring is hard.

Other versions of efficiency wage theory simply highlight that workers who are paid more are more productive. The canonical explanation is that the more you earn, the more nutritious your diet is and the more productive you are: productivity is an increasing function of wages. This is the version reviewed by Romer, for example. This is probably the more relevant version of the theory for China (Stiglitz's "shirking model" doesn't make much sense for electronics manufacturing, where presumably managers know how much each worker produces).

I remember my labor professor (Donald Parsons) told me once he didn't really buy into efficiency wage theory... I always thought it made decent intuitive sense. I'm not sure what kind of empirical work there is on it out there.
UPDATE: Xenophon raises a good point in the comment section. I'm not trying to make any statement about the working conditions in these factories. Suicides have all kinds of roots. Japan has a considerable suicide problem and it is an extremely wealthy country relative to China. I was more interested in what Foxconn hopes to gain from the wage increase, not in providing an explanation of the suicides or blaming Foxconn.
UPDATE 2: So I was thinking about this on the commute home last night and I want to make clear that there's also nothing implausible about arguing that this sort of industrialization leads to higher rates of suicide. I think Xenophon's point that the suicide rate is lower than the national suicide rate doesn't really get us very far. First there's what we call a selection problem. The people who get jobs in factories are going to be qualitatively different from the people who don't. Traditionally in developing countries we think about more skilled, ambitious workers moving to the industrial sector. The right group to compare them to isn't the country as a whole, but people like them that did not go to the factory. There are also probably simple composition problems. Do factory workers have families depending on them which makes them less likely to kill themselves? Probably - in that case you need to compare them to other people that have families depending on them. I'm agnostic on the suicide point - I could very easily believe that working in a Foxconn factory makes you more likely to commit suicide. I could also believe that it works the other way. That just wasn't my concern here.


  1. The suicide rate at these factories is actually lower than it is for the overall Chinese population. That doesn't mean improvements shouldn't be sought, but this fact should undercut all the moral outrage.

  2. Good point - honestly I wasn't even thinking about it in these terms, although I'm sure many people are. Ultimately it doesn't matter whether they're lower or higher than the general population for efficiency wage theory. The theory just says worker productivity is an increasing fuction of wages, regardless of where they started.

    I should have noted that this theory is offered as an explanation of unemployment. Efficiency benefits explain why firms would pay above-market wages, and above market wages explain unemployment.

  3. "I think Xenophon's point that the suicide rate is lower than the national suicide rate doesn't really get us very far."

    It really wasn't supposed to go further than to say, "Hey, the background facts look different than how they have been characterized by the media generally."

  4. No you didn't - again didn't mean to imply you yourself said that, I just wanted to qualify that we don't really know much from national comparisons.

    The article you linked, however, did say that "working at Foxconn dramatically reduces people’s risk of suicide".


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