Pay by the Piece Workers

Currently, I am reading Revolution In Time by David S. Landes. The book is about the history of time keeping, but it also introduced an interesting economics question (somewhere in chapter 4): how to increase the output of a firm that pays its workers by the piece.

Workers who are compensated by the number of units they produce often only work until they've earned "enough". Of course, enough is different for every worker but it's very hard to ask workers to work more.

There is usually no contract between the firm and its workers, so workers can come and go as they wish. However, the supply of skilled workers is limited to a certain extend in the short run. Therefore, the firm is not likely to hire more workers in the short run to increase its output.

Increasing the rate will not do either. As mentioned above, workers will only work until they've earned enough. Higher per piece rate will only decrease output from each worker because workers need to work less to reach that "enough" point.

If workers were only willing to work until they've earned enough and the firm wanted more output, then how about lowering the per piece rate? Workers need to work more (produce more output) in order to earn enough to satisfy their needs if the per piece rate is lower. The result is exactly what the firm wanted - more output and more product to sell.

This policy sounds good at first, but I am sure it will fail. Assuming that the workers work in a perfectly competitive industry, when the firm lowers the rate, workers can simply leave this firm and work for another one. Not only will the firm not able to increase its output, lowering the rate will likely to cause the firm to loose its ability to product all together. Also, this plan simply doesn't make sense. When the firm makes its decision to produce more, that means the demand for its product is going up. When demand goes up, price goes up (at least in the short run). When price goes up, profit goes up, usually. Profit is going up and the firm is cutting compensation? It just doesn't make sense. This policy will likely to achieve what Stravinsky had done in Paris with the Rite of Spring in 1913.

How, then, should we solve this problem? To solve it, we must first understand the problem. The problem here is that workers value the money they earn after a certain point (the point where they've earned "enough") less than the free time they have after work (or, more precisely, whatever it is that they do with their free time after work). In other words, the marginal utility workers get from working more than "enough" is less than the marginal utility from other activities.

Then, to increase the output with fix amount of workers, the firm simply needs to pay workers a higher per piece rate after they've eared "enough". This is not the same as just increasing the rate, because, in order to earn a higher per piece rate, the workers first have to produce a certain amount of output at the normal rate. Using this two tiers compensation system, workers are more willing to keep producing after earning "enough", because they know they are going to get more utility out of working than other activities.