Paying on the basis of output has advantages. There are two advantages. First, output-based pay induces the good workers to stay and the bad workers to leave the firm. If workers are paid exactly their output, they will leave whenever payments fall short of the wage at their alternative job. Conversely, all workers whose payments exceed the alternative wage stay on the job. Since a firm that pays a piece rate cannot pay its workers more per piece than they produce, those who stay are also those for whom output exceeds product in the alternative job. They are the workers whom efficiency dictates should stay at their current firm. The second reason for using output-based pay relates to incentives which mentioned above. Paying on this provides workers produce more. An example could be given to prove this. A recent paper by Lazear(1996) used data from one company to study the effects on productivity and wages of switching hourly rated workers to piece rate contracts(see also Pencavel 1977). Consistent with previous results, Lazear found that moving from an hourly wage to piece rate caused a 41% increase in productivity. The switch to piece rate also had the effect of decreasing absenteeism, which is another measure of worker productivity. In addition, output variance increased with the move to piece rates. Exploiting the fact that he could follow the same workers before and after the change, Lazear found that sorting and incentives both played an important role in the productivity gain, with more than half the gain being due to incentive effects.
Piece rate pay encourages effort, but it is argued, often at the expense of quality. From the employee’s perspective, there are some problems. For instance, if production machinery breaks down; if there is a problem with the delivery of raw materials that slows production. These factors are outside of the employee’s control, but could potentially affect their pay. The answer to these problems is that piece rate pay systems tend to have two elements in reality: a basic pay element, this is fixed (time-based); an output-related element (piece-rate). Often the piece-rate element is only triggered by the business exceeding a target output in a defined period of time.
The incentive properties of piece rate compensation schemes seem very attractive: works are paid for the work they do, not the work they could have done and this seems likely to solve problems associated with both hidden information(adverse selection) and hidden actions(moral hazard). However, Edwards(1979), argues that piece rate compensation schemes were ineffective because management did not know how fast a job could be done and therefore could not set use a worker’s performance to determine the correct rate because the worker responded by restricting output. It is taken into consideration that employers are going to the trouble of putting the job on piece rate and incurring continuing expense in counting and recording for the pay-roll after the rate in set. Piece rate can be negatively related to past output, because employers may use past performance as an indicator of the difficulty of a particular task. If workers perform very well early on, employers will come to believe that the task is relatively easy and will, therefore, lower the pay rates or increase the performance standard. This is known as “ratchet effect”. Realising this, workers may depress one period’s output in order to realise a better rate in the next period.
Piece rates also have two more serious disadvantages. The first arises because workers have private information about the difficulty of their jobs. Edwards(1979) summarises the historical record as follows:
“Piece rate always carried the allure of payment for actual labour done rather than labour power, thus promising an automatic solution to the problem of translating labour power to labour…as long as management depended on its workers for information about how fast the job could be done…there was no way to make the piece rate deliver its promise”.
Management faces both adverse selection and moral hazard problems: only workers know the difficulty of their jobs, and they can shirk so as to obscure this information from management. For risk averse workers, of course, agency theory proves that piece rates typically are an inferior solution to the problem of moral hazard and risk sharing and risk sharing and so presumably are an inferior solution to this more complicated problem as well.
The second shortcoming come to realised that piece rates stems from the firm’s opportunity to revise the rate over time. Clawson(1980) concludes:
“If workers could increase output, either by extra exertion or by improved methods of their own devising, they would receive higher wages…In practice, piece work never worked this way since employers insisted that they would never cut a piece once it was set, yet every employer did cut pieces…Unless workers collectively restricted output they were likely to find themselves working much harder, producing much more, and earning only slightly higher wages”.
Employers could cut rates in many ways other than changing the piece price for a worker who continued to perform the same operations. New workers could be assigned to the job at a lower rate while old workers were transferred elsewhere, information about output on the job could be used to lower the initial price on new work, and any sort of minor change could be made the excuse for large price cuts.
It could be conclude that the productivity effects associated with the switch from time wages to piece rates are very large. Market equilibrium is characterised by firms that choose a variety of compensation methods. Firms choose the compensation scheme by comparing the costs and benefits of each scheme. The benefit is a productivity gain. As a result of incentive effects, average output per worker rises. Thus, average ability should rise when a firm choose piece rates. However, piecework is not always profitable. Output is easily measured, quality problems are readily detected and blame is assignable. Furthermore, since the output is difficult to measure because of the difficulty in monitoring, the piece rate pay is not always working.
REFERENCES
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C. Goldin, “Monitoring Costs and Occupational Segregation by Sex: A Historical Analysis,” Journal of Labor Economics 4, (1986):1-27
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Edwaed P. Lazear “Performance Pay and Productivity” JSTOR
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Edwaed P. Lazear “Personnel Economics for Managers”, Chap5 pp100-104
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John H. Pencavel, “Work Effort, On-the-Job screening, and Alternative Methods of Remuneration,” Research in Labor Economics, ed. R..Ehrenberg, 1:225-58
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Robert Gibbons, “Piece-Rate Incentive Schemes” JSTOR
Piece rates are seen as a solution to the problems of adverse selection and worker shirking in the efficiency wage literature, such as in C. Goldin, “Monitoring Costs and Occupational Segregation by Sex: A Historical Analysis,” Journal of Labor Economics 4, (1986):1-27
John H. Pencavel, “Work Effort, On-the-Job screening, and Alternative Methods of Remuneration,” Research in Labor Economics, ed. R..Ehrenberg, 1:225-58
Lazear distinguishes incentive effects from pure selection effects by using fixed-effects regressions to purge the data from unobserved fixed worker-firm heterogeneity.
