Informal Incentives on Labor Markets – How Norms Shape Wages, Productivity, and Employment

Abstract

This paper theoretically investigates how norms on labor markets – which determine the equilibrium in self-enforcing agreements that firms use to motivate workers – affect outcomes. First, we show that an increase in the supply of homogenous workers can raise wages. Second, a discrimination equilibrium exists in which a group of majority workers, “insiders”, are paid higher wages than a group of minority workers, “outsiders”, although both groups are exante identical. Third, minimum wages can reduce discrimination, however at the expense of insiders, and furthermore increase employment. We discuss how these results are consistent with empirical evidence on immigration and a gender pay gap, and provide new testable implications.