Critically distinguish between   the efficiency wage and a market clearing wage

Efficiency wages are paid in order to give incentives to workers to be more productive and resourceful as higher wages will make shirking at work more risky as the loss of the job would mean greater monetary loss. Market clearing wages are the wages at the equilibrium where the demand and supply of labour is equated. The efficiency wages are above the market clearing wages and cause unemployment. However, even with excess supply of wages, efficiency wages are given to reduce wirker turnover, shirking, and adverse selection as worker wages are found to be positively correlated with firm performance.

Studies regarding the effect of wages on firm productivity indicate that there is a positive association between them. The results do support the efficiency wage hypothesis. However, the extent to which the correlation persists depends on the government policies and the labour market institutions. In fact, it has been noted that in many places low wages are the main cause for stagnating productivity.  So, firms need to ensure wage flexibility and worker bargaining rights to improve productivity.