The fair employment hypothesis: Reciprocity in unstable environments∗

We extend the well-known fair wage-effort hypothesis to situations in which firms suffer from negative productivity shocks and test experimentally whether a fair employment hypothesis exists. The fair employment hypothesis stipulates that firms employ workers even if it is not profitable for them in the short run (after a negative productivity shock) in order to induce reciprocal behavior. Our empirical results provide evidence for behavior that is consistent with the hypothesis. In contrast to the standard prediction of full unemployment for our setup after the negative productivity shock, unemployment is almost non-existent in the data, especially when a reputation mechanism is available. Gift-exchange between firms and workers is inter-temporarily robust in unstable productivity environments both with flexible and with rigid wages. JEL classifications: C92, J31, J63, J64