By Devashish Mitra and Priya Ranjan
Fairness considerations within the firm are introduced into the determination of wages in a two factor Pissarides-style model of search unemployment to study its implications for the unemployment rates of unskilled and skilled workers in both the closed economy case and when the economy can offshore some inputs. While the effect of a fair-wage constraint on unskilled workers takes the form of an increase in their wage and unemployment, we also OÌˆnd interesting effects on skilled workers in a closed economy. The skilled wage and skilled unemployment move in directions opposite to each other, with the actual direction of their movement depending on the elasticity of substitution between skilled and unskilled labor. The impact of offshoring of the services of unskilled labor on the unemployment of unskilled workers is stronger in the presence of fairness considerations than in the case when search frictions are the only source of unemployment. Finally, offshoring insulates the skilled labor market outcomes from fairness concerns that are present in a closed economy.
Our models typically assume cut-throat competition, yet there is some evidence that employers are willing to pay beyond the marginal productivity of labor, and not only for efficiency wage considerations. This paper introduces fair wages into a standard labor search environment and yields some interesting outcomes. It will be interesting to see whether the data corroborates the predictions of the model.