Effective Wages Theory and Unemployment Hysteria

8 mins read

Nowadays, when you switch on an economics channel, we are drowning in hundreds of economic schools and ideas. Sometimes we get lost in the sea of unknown concepts such as “Neo-Classical Thought” and sometimes “Post-Keynesian Thought”, and we expect simple explanations and suggestions for the way out. Today, as Ozan Kireççi, I decided to save you from these troubles by doing economics, which is my main job. We will share the Schools of Economics and their views in a series of articles. So what are we waiting for, let’s start with our first topic (since the topic I used in this article is the product of a joint group work, I should thank Öykü Gizem Alıcı for her literature review).

What caused the sudden emergence of economic schools?

Schools of economics have always been institutions that emerged with the end of a trend. Although our lessons start with “Mercantilism” because it is close to modern history, it actually dates back to the “Gatherer-Hunter” period, “Barter Economy” and the “Agricultural Revolution”. The most important situation that should not be overlooked here is that each school has emerged by opposing or developing the views of the school that existed before it. This is the most important thing to remember, Economics is a science in need of inherited knowledge, and the collapsed systems of the past have built today’s (what we think to be) healthy systems.

The school that emerged in the light of this information; “New-Keynesian School” and “Efficiency Wage Theory”

The New Keynesian School arose to criticize the New Classical School’s views and to provide a new perspective on the Keynesian System.The main goal was to strengthen the Keynesian Doctrine, which was weak in microeconomics, and to reintegrate it into the current economic system. As an example of the above paragraph, the New Keynesian school had to use the “Rational Expectations Hypothesis” when explaining the models within their system, and this view was integrated into Economic Science by the New Classical school.

What is the “Efficiency Wage Theory”?

Efficiency Wage Theory is an approach that establishes a positive relationship between the Labor Productivity and Real Wages. In this context, high real wages will increase the productivity of labour power, and this relationship will lead firms to set a real wage above the natural equilibrium level in order to increase labor productivity. Together with all the relationship networks formed, this tendency will lead firms to create “Real Wage Rigidity“. (Levent Dölek-2013)

In times of crisis, wages, which should be flexible according to the teachings of the New Classical School of Economics, should fall, but this is not the scenario in practice. Due to the positive causality between Real Wages and Productivity, firms may find the cost of paying high real wages more profitable than the cost of productivity decline in times of crisis and may continue to pay high real wages. (Assoc.Dr. Metin Altıok-2009)

Thus, since Efficiency Wages reach a value that exceeds market equilibrium wages, it creates a labour supply surplus with involuntary unemployment, but Shapiro and Stigliz argue that a higher level of unemployment increases the effort of workers. The underlying rationale for this thesis is that low-effort workers work more willingly because they find it difficult to find a job again in a labour market with high unemployment. At the same time, above-equilibrium wages employ qualified labour and relatively prevent phenomena such as unqualified labour and job shirking. (OMU-2022)

Unemployment Hysteria” and the New Keynesian School

Unemployment Hysteria, as a concept derived from this model, was first introduced by Olivier Blanchard and Lawrence Summers. They argued that long-term unemployment rates push up natural unemployment rates and that such actions again affect long-term unemployment rates. (Dr.Mahfi Eğilmez-2019)

Taking trade unions as a case study;

Unions show resistance against the decline in real wages of their members → Resistance prevents unemployment from decreasing and approaching zero by decreasing real wages → In long-term unemployment environments, some members become unemployed due to the fact that real wages do not decrease and union rights are terminated, unions lose members → Unions prevent their former members from finding a job by opposing the decrease in real wages.

With this situation, unions that show a reflex to defend the rights of their members by preventing the decline in real wages in the first process, and unions that create an environment of long-term unemployment by preventing the decline in real wages with their bargaining power in the following processes, both put the employment status of their members at risk and limit the opportunities of their former members to find a job. (Dr.Mahfi Eğilmez-2019)


Schools of economics bring problems as well as solutions. At this point, the New-Keynesian School, which was born as a reaction to the Neo-Classical School, turned the assumptions of the past school into a series of problems in this way. They produced solutions for this situation and went to the point of implementing them with their policies. This is the most entertaining part of economic science; to carry a constant “scepticism” and to be necessarily dynamic. Models and theories that are correct for economic science today may turn out to be very wrong or (although examples are rare) stereotypes tomorrow. This is why economics is a “Social” science and is not based on precise formulae and conclusions like other “Positive” sciences. Economics is as uncertain and skeptic as the people who create it; it learns from the past and uses its teachings to create the present.Just like “Society”…

Best Regards and Wishes



1- Dr Mahfi Eğilmez (2019); “Ekonominin Temelleri”; Remzi Kitabevi, 2nd Edition p.191
2- Ondokuz Mayıs University (2022); ” Ücret Teorileri Ders Notları “; AVYS
3- Assoc. Prof. Dr. Metin Altıok (2009); ” Keynes ve Keynesçi Kuramda Kriz ve İktisat Politikası Tartışmaları “; Thematic Writings, Toplum ve Demokrasi, 3 (6-7), May-December, 2009, pp. 75- 102.
4- Research Assist. Gör.Levent Dölek (2013); “İktisat Teorisinde İşsizlik Olgusu Ve Emek Piyasası”; Istanbul University Institute of Social Sciences, Department of Economics, PhD Thesis


Ozan Kireççi

Istanbul University, Departmant of Economics, Interested Economics and Political Science.

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