Efficiency Wages and Worker Productivity: How Investment in the Workplace Can Be a Sound Economic Decision

In 1984, economist George Akerlof formalised the belief held by many employers that paying workers above the market price (i.e. the market-clearing wage) will increase worker productivity to a level that will more than offset the cost of paying higher wages.

In addition to paying above market wages, Akerlof's efficiency wage theory posits that by investing in better production methods and providing a good working environment for employees, employers also add to their employees' human capital. The economic effects of investing in employees' human capital are much larger than simply providing better salaries and benefits.

Workplace Investment and Total Factor Productivity

The decision to invest in workplace inputs should be based on a careful evaluation of costs and benefits and an analysis of total factor productivity (TFP) — the growth of all outputs other than those attributable directly to the increase in the number of employees or the increase the amount of capital in use in a particular firm.

In 2025, TFP growth in the US nonfarm sector was 0.8%, after 1.5% growth in 2024, which indicates that companies are developing new ways to produce more for every unit of input, or TFP. One important but often overlooked factor influencing TFP growth is workplace quality. Where the workplace environment enables work and facilitates the removal of barriers to productivity (e.g. giving employees adequate breaks, using modern tools and equipment, etc.), TFP growth will be higher than otherwise. Poorly designed work environments, lack of employee support, or restricted access to information are just some of the factors contributing to workplace underinvestment.

Businesses should also ensure that employees have access to the necessary hardware and supplies. For example, maintaining adequate stocks of printer consumables, including HP ink, can help prevent unnecessary interruptions to daily operations.

The cost of neglecting workplace investments

There are quantifiable costs associated with neglected workplace investment. In the US, an estimated one million workplace injuries are attributed to musculoskeletal disorders each year, resulting in approximately $20 billion in worker's compensation claims. Total annual costs associated with musculoskeletal disorders are estimated to range from $13 to $54 billion according to the National Institute for Occupational Safety and Health (NIOSH). An office worker working in an ill-suited workstation for eight hours per day suffers physical stress, which produces diminished productivity. Therefore, the seat selection and seating posture of workers is extremely important. Ergonomic chairs are a type of capital investment predicted to return dividends, according to efficiency wage theory: a modest upfront capital investment that minimises the likelihood of injury, improves focus, and reduces the number of employee absences. SHRM has reported that, as a result of the increased injuries associated with musculoskeletal disorders, productivity decreases by 36.6%, resulting in an estimated cost to employers of $3,600.00 per employee per year.

The Principal-Agent Problem and the Gap of Externalities

The principal-agent problem further complicates the cycle of employment and the employment market. Employers incur at least the initial costs of investing in the workplace while the gains from those investments go to both the employee and the public health system. The misalignment of incentives results in the production of negative externalities: companies that are unable or unwilling to invest in a productive work environment create costs for parties other than themselves, including the public health system. In situations where businesses have no obligation to factor these downstream costs into their operations, the marketplace is unable to provide safe working environments in a sustainable way. This provides a strong rationale for government intervention based on Pigouvian incentive structures.

Amazon, as well as Bain & Company's research, demonstrate the consequences of a low investment in safety. Amazon employs over a million employees, and has one of the highest injury rates among warehouses across all industries, recording a nearly twofold greater injury rate compared to the average rate of 6.6 per 100 FTEs in the warehouse sector. Approximately 70% of their employees reported time lost without pay as a result of pain or exhaustion. Amazon's throughput-driven model was not able to recognise all the costs being placed on their employees and the U.S. public healthcare system. On the other hand, Bain's analysis of the successful companies who heavily invest in their people like Apple, Google and Dell found that these companies, on average, are 40% more productive than other companies and, as a result, have an average profit margin of 30%–50% greater than their peers. Studies have shown that the return on investment (ROI) of ergonomic interventions can range from 2:1 to 10:1 — an ROI that would be considered very attractive under any capital allocation criteria.

Moral Hazard, Incomplete Information, Productivity Stagnation

Moral hazard is yet another layer of difficulty. After an employer has accepted all the responsibility for the employee's compensation or health insurance, both the employer and the employee are likely to have an incentive not to report discomfort, which diminishes the likelihood of making preventive investments. Both parties also have an incentive to shift their costs to their respective insurance companies. Economists have recognised that the misalignment of incentives and the incomplete information concerning the employment relationship has led to chronic underinvestment in worker welfare from both an organisational and an economic perspective; this does not mean that the organisations are indifferent to productivity, rather it means it is not easy to demonstrate a causal relationship within standard accounting practices between a specific environmental input and a measurable output. In most cases in 2023, multifactor productivity growth has stagnated or declined for the majority of OECD countries, with an average estimated growth rate of about 0.4% for 2024. Therefore, businesses that treat workplace investments as a residual budget item and not as a strategic investment produce output below their true production possibilities, causing underutilisation of their resources and externalising the costs of these losses to the employee and society.