Adam Smith and the New Economics of Effort

Neo-classical economists pay implicit tribute to Adam Smith by their continuing adherence to his view of the labour market. ‘Of the many ideas of Adam Smith that have stood the test of time,’ writes Albert Rees (1975, p. 336), ‘few have weathered better or are still more relevant than the idea of compensating wage differentials’, Yet Smith’s theory that a competitive labour market rewards workers for skills that are costly to acquire and for the disamenities associated with their work has stubbornly defied empirical verification. One explanation for this resistance to empirical tests, the efficiency wage theory, holds that the moral hazard involved in eliciting labour effort imposes a distorting layer of rents on the structure of pay.