Will higher wages lead to higher labor productivity?


Mitsuo Shiota


February 17, 2022

Associate Professor Izumi Yokoyama at Hitotsubashi University published an article titled “Gov’t promotion for higher wages will have limited effects on productivity” (Japanese) in “Lecture on Economics” in Nikkei news paper on February 17, 2022.

Although I agree to what the title says, I am surprised at her reasoning.

She considers whether higher wages promoted by the government will lead to higher labor productivity, both (a) under the completely competitive labor market model, and (b) under the efficiency wage theory model.

In case of (a), her answer is “yes”, as wages equal to marginal labor productivity. In case of (b), her answer is “limited”, as the opportunity costs of losing jobs for employees don’t increase, because they can find jobs from other employers which also raised wages following the government promotion.

I would like to show my answer here. In case of (a), absolutely “no”, as wages are determined by the market, and the government promotion has no effects in the first place. She is wrong in thinking higher wages cause higher productivity, though in fact higher wages reflect higher productivity.

In case of (b), probably “no”. As the opportunity costs of losing jobs increase, employees will try to enhance productivity. However, all will not succeed, and employers will cut failed employees. So employment will be reduced. Although productivity per hours worked may increase a bit, productivity per labor force may even drop. She is wrong in forgetting the efficiency wage theory was invented to explain persistent involuntary unemployment.

Near the end of the article, she says government promotion of wage increase is expected to stimulate the economy, which is still suffering from Covid-19. I think this is the only path where wage increase campaign may increase productivity in the short term.