Minimum Wages and Relational Contracts

Abstract

The need to give incentives is usually absent in the literature on minimum wages. However, especially in the service sector it is important how well a job is done, and employees must be incentivized to perform accordingly. Furthermore, many aspects regarding service quality cannot be verified and relational contracts have to be used to provide incentives. The present article shows that in this case, a minimum wage increases implemented effort, as well as the efficiency of an employment relationship. Hence, it can be explained why productivity and service quality went up after the introduction of the British National Minimum Wage, and that this might actually have caused a more efficient labor market. Furthermore, if workers have low bargaining power, a higher minimum wage also increases profits and consequently employment. Therefore, the present article presents a new perspective on reasons for why minimum wages often have no or only negligible negative employment effects (JEL C73, D21, J24, J31).