Wages and the Intensity of Labor Effort: Efficiency Wages Versus Compensating Payments

The distinction between efficiency wages and compensating payments is, at best, rather vague in both the theoretical and empirical literatures positing a relationship between wages and the intensity of labor effort.' While efficiency wages and compensating payments are both related to work intensity, the mechanisms that generate these relationships are in each case quite distinct. Compensating payments exist in competitive labor markets to equalize overall compensation across identical workers with dissimilar working conditions. Workers who expend more labor effort must be paid more or they will seek employment elsewhere. Efficiency wages are employment rents paid by firms in order to ensure adequate labor effort. These rents vary with the costs firms face in monitoring labor effort. They cannot be competed away because without employment rents, profit-maximizing levels of work intensity would not be forthcoming. In this paper we distinguish between the efficiency wage and compensating payments components in wage differences across workers and firms. In the first section of the paper, we use a theoretical model of optimal labor effort choice by workers and firms to make these two com-