Akerlof's Gift Exchange Model - For Tuesday 10/14

JSTOR: The Quarterly Journal of Economics, Vol. 97, No. 4 (Nov., 1982), pp. 543-569 via kwout

Akerlof's theory is rather simple to articulate, as is the debate over how best to do compensate employees to make them most productive.  (Akerlof's model is the basis of one side of the debate.  The model for the other side is the principal-agent model.)  The quintessential issue is whether pay should be performance based and hence vary from individual to individual who hold the same job (one view of compensation that is associated with the principal-agent model) or if instead pay should be position based and not feature such idiosyncratic variation, except perhaps on a seniority basis (the alternative view of compensation that comes out of Akerlof's model).   Of course, those in the second camp don't deny that performance matters.  Where they differ with those in the first camp is on how excellent performance should be rewarded.  For those in the second camp promotion should be the primary reward for exceptional performance.  They believe that within a job classification, the workers need to be managed fairly, which provides the basis for equal treatment.  This is the essence of the view that emerges from Akerlof's model.  

The vision for why this alternative to the principal-agent model produces superior performance was supplied by Dumas père in The Three Musketeers.  It is embedded in the relationship between Athos, Porthos, and Aramis (the workers doing the same job) and D'Artagnan (their manager) and is captured in the phrase, "All for one and one for all."  Akerlof crafts that vision and related ideas from sociology to make an economic model of it.  For the non-economist, it might be framed as collegiality-driven productivity.  Here are the model's basic elements.

There is a minimal performance standard below which the employee will get fired.  There is a performance norm, substantially above the minimal standard, that typifies what workers produce.  The difference between the minimal standard and the higher norm constitutes a gift that workers give to the firm.  Likewise, there is a minimal wage below which workers would quit and find work elsewhere and there is an actual wage above that minimum that the firm pays to workers.  The difference is a gift that the firm gives to its employees.  Gift giving demands reciprocation for it to be sustained.  When that happens all involved feel good about the place of work and productivity is high as a consequence.

There is one more piece to the puzzle in the Akerlof approach.  This regards how productivity is observed and what explains variation in productivity from one worker to the next and for one worker over time.  From the worker's own perspective, this is mainly due to random factors - circumstances beyond the employee's control.  Or, in the case where there is clearly a drop off in a particular employee's performance, it can be attributed to outside of work stresses (e.g., a sick child at home) that are apt to be temporary in nature.  The correct response in this case is not to punish the employee but rather for co-workers to chip in and pick up the slack.  Sometime in the future, the employee who received such help will lend a hand when another co-worker has a similar problem.

Applying the approach specifically to how teachers in K-12 should be compensated, because that has gotten a lot of attention in public debate, the principal-agent approach is consistent with pay performance pay based on student test scores, while the Akerlof approach would avoid that in favor of seniority based pay.  An advocate of the principal-agent approach but with an open mind might grant that collegiality-driven productivity can be a good thing, as long as the fire burns within all the workers, but will argue that eventually a worker burns out and turns into dead wood.  That is not temporary.  It is a permanent change.  Then the follow up argument is that seniority based pay sustains the dead wood, who act as a drag on the entire system.  One needs, instead, a time-consistent way to purge the system of the dead wood.  Performance based pay does that.

Akerlof's model does not address that critique.  I will provide my own answer below, but before I do  let me take a slight detour.  The Akerlof gift exchange model is essentially social in nature.  There is a different reason to depart from performance based pay that is intellectual in nature and is particular to knowledge work.  This other view is articulated by Daniel Pink in this RSA Animiate video and focuses on psychological explanations for productivity.  There can be performance anxiety or, if you prefer, writer's block. High performance is achieved when intrinsic motivation is strong and the individual becomes so involved in the work as to entirely lose a sense of self.  Making extrinsic rewards overt moves the individual's focus away from the intrinsic motivation and thereby lessons productivity.  Better to have the economic rewards provided up front so that one can put them out of mind when the real work commences.  While I have critiqued this video on how it represents the economics, I concur with its representation of the importance of intrinsic motivation. 

Burnout then can be thought of as the disappearance of intrinsic motivation.  The response on the burnout issue is to look at the causes for why intrinsic motivation should disappear.  One possible cause is a sense of plateauing in the work.  There is little left to learn, no inherently new challenges.  For the most part it is a rehash of what's come before - been there, done that.  This cause is consistent with the principal-agent view.  When it happens, it would seem to make sense that the worker should move onto a new challenge; do something else, especially if one has a sense that new challenges would rekindle a fire in the person.  There is, however, a different cause that is also possible.  It is that the individual confronts organizational barriers that seem arbitrary and anti-productive and those barriers repeatedly thwart the individual's creative efforts.  Eventually, the individual wears down from not seeming able to accomplish sensible change.  Gallows humor becomes part of the routine as the individual loses the desire to fight the system.  This second cause might reasonably dictate that more fundamental organizational change is necessary.  The burden shouldn't be placed on the individual to accommodate organizational inertia.

It is this second cause that forms the basis of for tying the motivational issue to the organizational ones.  The Akerlof gift exchange approach must happen within a dynamic organization that makes organizational learning paramount.  (See Senge's The Fifth Discipline.)  Employee burnout might still happen in such organizations, but it would be far rarer.  When it does happen the appropriate organizational response should be job reassignment rather than immediate severance, this in accord with the gift exchange view.  Collegiality, in tone and actual practice, then characterizes good jobs and is at the heart of how the organization remains productive.

The above is in accord with my experience as a campus administrator.  In my years working in learning technology, everyone I've encountered knows the benefits of collegiality for productivity, though I expect that the vast majority of them were not acquainted with Akerlof's gift exchange model.  Performance based pay seems logical and in certain instances (sales, in particular) even those who believe in collegiality will acknowledge the benefits of performance based pay.  But, as it de-emphasizes collegiality in favor of individual performance, in other contexts performance-based pay can be counter-productive.