Ratchet effects occur when workers have private information (about their own ability or the difficulty of the task),  AND when revealing this information does not affect the value of workers' opportunities outside the current firm.   In these situations, profit-maximizing employers will exploit positive information about productivity by reducing pay.  Anticipating this, agents will try to conceal such private information from employers by restricting their output below economically efficient levels.   

Core Readings

Mathewson, S. Restriction of Output among Unauthorized Workers New York, Viking Press (1931). See especially chapter 3.

Compelling anecdotal evidence, based on interviews with production workers, that workers collude to keep output low in order to avoid ratchet effects, i.e. cuts in their piece rates or increases in their production goals in response to high worker effort. 

Gibbons, Robert (1987), “Piece-Rate Incentive Schemes” Journal of Labor Economics 5 (October): 413-29.

The first formal model of ratchet effects, based on hidden information possessed by workers, inspired by the history of failed attempts to install piece-rate compensation schemes at the turn of the 20th century.  The main result is that when neither the firm nor the worker can commit to future behavior, no compensation scheme, piece-rate or otherwise, can induce the worker not to restrict output. 

Cooper, David J., John H. Kagel, Wei Lo and Qing Liang Gu (1999), “Gaming Against Managers in Incentive Systems: Experimental Results with Chinese Students and Chinese Managers” American Economic Review 89(4), (Sept): 781-804.

In a lab experiment on Chinese firm managers, the managers learned to strategically reduce output only after acquiring significant experience with the game. 

Carmichael,  H. Lorne and W. Bentley MacLeod (2000) Worker Cooperation and the Ratchet Effect Journal of Labor Economics , Vol. 18, No. 1 (January 2000), pp. 1-19.

When product markets are competitive and worker's productivity-enhancing ideas 'leak' outside their firm,  Carmichael and MacLeod show that it is always in workers' interests to keep these ideas to themselves (in order to prevent future pay cuts.)   In less-competitive situations and when new ideas don't leak, however, it may be possible for workers to benefit from revealing such information.   The authors provide intriguing illustrations of how this can be achieved from two case studies:  Lincoln Electric and cotton spinning industry in England in the nineteenth century. 

Charness, Gary, Peter Kuhn and Marie-Claire Villeval, “Competition and the Ratchet Effect”, Journal of Labor Economics 29(3) (July 2011): 513-47.

Models the ratchet effect as a multi-period principal-agent problem with hidden information. In an experimental setting, demonstrates that workers restrict effort when they know their principal might interpret high performance as evidence of high worker ability.  Shows how introducing market competition into the labor market eliminates ratchet effects.

Newer Resources

Cardella, Eric and Briggs Depew, (2018). “Output restriction and the ratchet effect: Evidence from a real-effort work task," Games and Economic Behavior, 107(C):182-202.

Investigates the presence of the ratchet effect using a real-effort work task and a piece-rate incentive scheme. Findings show strong evidence that workers restrict output when productivity is evaluated individually.   When productivity is evaluated at the group level, output restriction only occurs when workers are allowed to communicate with each other.   In Cardella and Depew's context, output restriction has an additional cost that has not been detected in previous studies-- reduced producitivity growth due to a reduction in learning by doing.

Jeffrey C. Ely and Martin Szydlowski, "Moving the Goalposts," Journal of Political Economy 128, no. 2 (February 2020): 468-506.

This theory paper considers a situation where –in contrast to the standard ratchet effect model-- the principal but not the worker knows the difficulty of the task.  The optimal contract involves “moving the goalposts”:  the principal first gives the agent just enough information to suggest that the task may be  easy.  If the task is indeed difficult, the agent is told this only after working long enough to put the difficult task within reach. The agent then completes the difficult task even though he never would have chosen to at the outset.  

Matejka, Michal, Matthias D. Mahlendorf  and Utz Schäffer 2022 The Ratchet Effect: Theory and Empirical Evidence  Management Science, forthcoming.

The authors study the target-setting process for a sample of European financial executives between 2011 and 2019.  Inconsistent with models of the ratchet effect, they find that managers who exceeded their target in one year report that they find their next target easier to achieve.  One possible explanation is that principals use generous target revisions as rewards for high levels of past performance. 

Abeler, Johannes, David Huffman and Collin Raymond. 2023  Incentive Complexity, Bounded Rationality and Effort Provision  CESifo Working Paper No. 10541.

 The authors study a workplace where a worker’s future piece rate is reduced (via a formula) if they produce more output today.  In this setting, how can the firm prevent workers from strategically restricting their output today (to avoid future rate cuts)?  The authors show that ‘shrouding’ (i.e. making the connection between today’s performance and tomorrow’s pay rate harder to understand) can achieve this goal.