Wage Subsidies and Fair Wages

Wage subsidies can be provided directly to the worker, or indirectly by subsidizing the employer; with reduced cost of labor, employers offer higher wages. The standard literature stipulates that this statutory incidence bears no implications for the economic incidence. We propose and test a mechanism by which indirect subsidies lead to higher social welfare. Studies show that workers reciprocate higher wages with higher effort. Indirect subsidies are shifted to the workers as higher wages, leading workers to reciprocate with higher effort and productivity. A controlled laboratory experiment supports our behavioral hypotheses and confirms the behavioral and welfare implications.