Fair wages, Urban Unemployment and Welfare in a Developing Economy

This paper studies the impact of pay fairness on factor income and social welfare in a developing economy with both modern urban and traditional rural sectors. When urban workers become aware of income fairness, they use the expected urban wage and weighted average returns to capitalists as their reference pay. This perception of fairness raises the urban wage and enlarges the wage gap between the urban and rural sectors. The ensuing above market-clearing wage rate causes urban unemployment. Greater wage fairness worsens urban unemployment and lowers social welfare in the economy.