Key Takeaways
- Fair Wage-Effort Hypothesis: Workers supply fraction of normal effort when actual wage less than perceived fair wage.
- Mechanism: Underpayment causes anger, reducing labor input.
- Antagonistic Outcomes: Comparative concern causes output restriction, efficiency losses, unemployment, sabotage.
- Wage Compression: FWEH explains observed wage compression, making internal structures more egalitarian.
- Reference Groups: Fair wage based on comparisons with co-workers in same firm.
The Fair Wage-Effort Hypothesis
Comparative concerns translate into measurable inefficiency within the workplace. Managers and policymakers must recognize that competition quickly undermines group performance if fairness is absent. The Fair Wage-Effort Hypothesis (FWEH), motivated by equity theory in social psychology and social exchange theory in sociology, precisely quantifies this behavioral response. This hypothesis states that workers possess a conception of a fair wage ($w^*$); if the actual wage ($w$) falls below this standard, workers respond by proportionally withdrawing effective labor input. This behavior follows the functional form: $e = \min(w/w^*, 1)$, where $e$ is effective effort supplied and 1 denotes normal effort.
The core motivation is simple human behavior: when people do not get what they deserve, they try to get even. When the actual wage is less than the fair wage, workers become angry. The consequence of this anger is a reduction in effective labor input below the level they would offer if fully satisfied. Sociological studies observed this exact phenomenon decades ago, noting that workers adjust production to the pay received when they perceive their wage as unfair. Empirical studies testing this implication for underpaid subjects are strongly supportive.
The Economic Consequences of Comparative Concerns
Comparative concerns introduce significant economic drag through output restriction, antagonism, and spite-based sabotage. Workers reduce their effective labor power when they feel under-rewarded. One experiment found that underpaid interviewers produced interviews of significantly lower quality. In organizational studies, two-tier wage systems generated intense resentment among employees, leading to high turnover and hostility directed at customers.
More destructively, envy incorporates antagonism and output restriction into the economic structure. When an agent’s well-being falls behind a rival’s, envy can motivate costly action aimed at reducing the rival’s status or success. This anti-social behavior includes innovation retaliation and sabotage. Within the context of the FWEH, this anger and desire to “get even” results in output restriction. For example, workers discontented by an unfair ratio between wages and profits intentionally put too much stress on a machine, causing paper to tear, which required difficult and unpleasant cleanup work—a clear act of costly output reduction. The threat of such envious retaliation, which manifests as economically damaging deadweight loss, actively deters innovation.
Wage Compression as a Mitigation Strategy
The observed phenomenon of wage compression, where pay is highly egalitarian regardless of productivity differences, can be seen as the market’s attempt to mitigate the economic drag imposed by the FWEH. By paying their least productive workers more than their marginal product, firms compensate them for occupying lower-ranked positions within the internal hierarchy, thereby managing discontent and preventing disruptive behavior. If firms did not compensate low-ranked workers for their reduced status, they would risk high turnover, open disruption, and replacement difficulty. Thus, the wage structure within firms is fundamentally influenced by concerns about the wages earned by co-workers, serving as a mechanism to preserve the organization’s stability and workforce performance.
What's Next?
The FWEH confirms that labor productivity cannot be isolated from social comparison. The drag caused by status competition necessitates quantifying the aggregate economic deadweight loss from malicious behaviors such as **sabotage and diminished cooperation**. Mitigating this drag requires organizational design that either reduces the visibility and importance of local status comparisons or actively channels competitive pressure into the productive, self-improving **benign envy**.References
- Akerlof, George A., and Janet L. Yellen. (1990). The Fair Wage-Effort Hypothesis and Unemployment. The Quarterly Journal of Economics, 105(2), 255-283.
- Frank, R. H. (1985). Choosing the Right Pond. Oxford University Press.
- Mui, V. L. (1995). The economics of envy. Journal of Economic Behavior and Organization, 26(3), 311-336.
- Grossman, P. J., & Komai, M. (2013). Within and Across Class Envy: Anti-Social Behaviour in Hierarchical Groups. Discussion Paper 02/13.