Efficiency wages were put forward as a cause of what is now called precarious work. The efficiency wage hypothesis breathed considerable new life into the old theory of dual labour markets (Katz 1986; Dickens and Lang 1985).
The notion of a segmented labour market, of a primary and a secondary labour market, each with distinctly different wage setting mechanisms, was very much a fringe idea prior to the 1980s:
Efficiency wage theory provides a rare common meeting ground for mainstream and radical economists, because the far left in U.S. economics has taken the lead in developing theories of dual labor markets and for setting-out policy proposals for higher minimum wages based on the assumed validity of the efficiency wage approach (Gordon 1990, p. 1157).
The workers privileged enough to hired by firms paying an efficiency wage would enjoy job security, low job quit rates, good working conditions, career advancement, training and higher pay (Akerlof 1982, 1984; Bulow and Summers 1986; Dickens and Lang 1993). The remaining equally productive workers who were unlucky enough to be priced out of these good jobs by the job rationing implicit in an efficiency wage must fend for themselves in a secondary labour market; in precarious work with high quit rates, harsh workplace discipline, few promotions, little training and poor pay (Akerlof 1982, 1984; Katz 1986; Dickens and Lang 1985). Efficiency wages do not motivate greater employee effort unless the prospect of precarious work in this secondary labour market looms large in the back of their minds as their main alternative source of employment for those lucky enough to be employed in the good jobs in the primary labour market (Katz 1986; Bulow and Summers 1986).
Those workers crowded into these bad jobs in the secondary labour market find it to be a slow and difficult process to break into these better paying good jobs in the primary labour market. There are queues for the good jobs because they are paying above-market wages; many of those crowded into the bad jobs are women and minorities (Bulow and Summers 1986; Dickens and Lang 1985, 1993).
Akerlof, in his Nobel Prize lecture on behavioural macroeconomics, contended that the good and bad jobs caused by paying efficiency wages is central to explaining involuntary mass unemployment:
The existence of good jobs and bad jobs makes the concept of involuntary unemployment meaningful: unemployed workers are willing to accept, but cannot obtain, jobs identical to those currently held by workers with identical ability. At the same time, involuntarily unemployed workers may eschew the lower-paying or lower-skilled jobs that are available. The definition of involuntary unemployment implicit in efficiency wage theory accords with the facts and agrees with commonly held perceptions. A meaningful concept of involuntary unemployment constitutes an important first step forward in rebuilding the foundations of Keynesian economics (Akerlof 2002, p. 415).
Living wage activists already doubt that the market can provide steady wages growth and stable employment. Efficiency wages are a leading New Keynesian macroeconomic explanation for that. The living wage movement cannot pick and choose from what the efficiency wage hypothesis says about how well the labour market functions for those who are and are not in efficiency wage jobs.
Living wage activists are unwittingly following a course of action that leads to more job rationing, more precarious work and more unemployment. Those priced out of council jobs by a living wage such as the 17 parking wardens are left to take their chances in the rest of the local labour market. These workers must take bad jobs while queueing for the good jobs in the primary labour market. Instead of being sources of opportunity in their communities, councils through a living wage policy risk becoming drivers of labour market segmentation and the fostering of a precariat.
Two Lucky People: Memoirs By Milton Friedman, Rose D. Friedman, p.246.