Effort and the Cycle: Cyclical Implications of Efficiency Wages

A number of authors have proposed theories of efficiency wages to explain the behaviour of aggregate labor markets. According to these theories, firms do not adjust wages downwards despite available unemployed job seekers, because lower wages would induce hired workers to shirk more often, which in turn would be counterproductive for the firm. Efficiency wage theories thus aid in explaining, why \involuntary" unemployment can persist. According to one popular version by Shapiro and Stiglitz (1984), it is precisely the threat of unemployment which induces workers to provide effort. The purpose of this paper is to examine the cyclical consequences of an efficiency wage theory, when effort is an adjustable variable. To that end, we ex- amine such a theory in the context of a dynamic real business cycle framework. The paper shows, that increasing the variability of effort due to efficiency wage consideration helps in explaining the rather large cyclical employment move- ments as well as the rather low cyclical movements in real wages, supporting the point made by Solow (1979), but require unplausibly large movements in the technology parameter. Because of the latter aspect, we argue that adjustable effort due to effciency wage considerations is unlikely to play an important role for understanding business cycles