A Behavioral Account of the Labor Market: The Role of Fairness Concerns

Abstract

In this paper, we argue that important labor market phenomena can be betternunderstood if one takes (i) the inherent incompleteness and relational nature of mostnemployment contracts and (ii) the existence of reference-dependent fairness concerns among a substantial share of the population into account. Theory shows and experiments confirm, that even if fairness concerns were only to exert weak effects in one-shot interactions, repeated interactions greatly magnify the relevance of such concerns on economic outcomes. We alsonreview evidence from laboratory and field experiments examining the role of wages and fairness on effort, derive predictions from our approach for entry-level wages and incumbentnworkers’ wages, confront these predictions with the evidence, and show that referencedependentnfairness concerns may have important consequences for the effects of economic policies such as minimum wage laws.