How Minimum Wages and Consumer Preferences for Fair Treatment of Workers Interact

By David Danz, Dirk Engelmann, and Dorothea Kübler

The behavior of firms with respect to ethical issues, such as the treatment of workers or the impact on the environment, is receiving increasing attention. Consumers can make their purchasing decision based on how firms treat their workers or the environment. As a result, it can pay for firms to behave ethically in order to attract such consumers. Alternatively, the traditional economic approach to such issues is regulation. In this approach, the government prescribes the fulfillment of certain standards and does not rely on individual consumers’ willingness to pay from their own pocket to buy more expensive products that they consider to be more ethical. This raises the question of how the preferences of consumers and regulation interact. Specifically, will regulation undermine the consumers’ motivation in the sense that if firms are forced to satisfy a certain, but relatively low standard, consumers are no longer willing to pay a higher price by switching to a firm that follows more ambitious standards? If this happens, the overall effect of regulation is ambiguous.

A sizable body of literature based on laboratory experiments shows that people are concerned with fairness and are willing to forego earnings in order to punish unfair behavior or reward fair behavior. However, most of this literature deals with reactions of agents in response to how others have treated them. A smaller strand of the literature also finds that participants reward and punish the fair and unfair treatment of third parties. A subset of this literature suggests that this behavior tends to survive even in markets, whereas other contributions indicate that market interactions per se already crowd out fairness. The finding that fair consumer choices can be observed in markets is important, because people may decide more selfishly in markets, since their impact is small and they believe that their choice will not affect the behavior of firms. Furthermore, consumers may think that what they do not buy will be bought by others, which undermines their own impact.

BCCP Senior Fellows Dirk Engelmann and Dorothea Kübler and their co-author David Danz investigate the impact of regulation in such a market, where consumers can try to influence the behavior of firms. Specifically, they investigate the effect of a minimum wage on the intrinsic fairness of consumers. In each experimental market, a single consumer interacts with two firms, which are composed of one manager and one worker each. The manager sets prices and wages, while the worker takes no active role and, hence, has no power to affect the firm’s result. The consumer knows the prices and wages of both firms. In the base scenario, wages are unregulated. In an alternative scenario, wages are regulated to meet at least a given threshold, which is, however, far below a wage that would amount to an equal split of earnings among workers, managers, and the consumer. In line with earlier research, consumers are frequently buying from the firm with the higher price if it also pays the higher wage. In the presence of a minimum wage, they do this less frequently. However, the negative indirect effect on worker’s wages through a decreased willingness of consumers to pay more for higher wages is smaller than the positive direct effect of the minimum wage that is observed in situations where consumers and firms act relatively selfishly and, hence, wages would otherwise be below the minimum wage. Thus, in the setting of this study, the total effect of the minimum wage is positive for workers.

Overall, the experiments show that regulation can crowd out intrinsic fairness concerns, thereby counteracting the direct effect of a minimum-wage regulation. Whether this crowding out dominates the positive direct effect and, hence, whether the total effect of the regulation is negative or positive, depends on the specifics of the market.

The full paper “Do Legal Standards Affect Ethical Concerns of Consumers” is available as CRC TRR 190 Discussion Paper No. 234.

This text is jointly published by BCCP News and BSE Insights.