cahuc_labor economics_ minimum wage

8/2/2019 Cahuc_Labor Economics_ Minimum Wage

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Labor Economics:

Pierre Cahuc, http://pierre.cahuc.googlepages.com

March 2010The minimum wage

Popular justi…cation of the minimum wage: strengthens the hand of

the low skilled workers who are exploited by monopsonist employers

Monopsony: minimum wage may useful because it increases both em-

ployment and the income of low wage workers

This view had a strong in‡uence on economic policy in the last decade

Card and Krueger (1995)



OECD Jobs Study, 1994: “reassess the role of statutory minimum

wages as an instrument to achieve redistributive goals, and switch to

more direct instruments.” OECD Employment Outlook, 1998: “a well-designed policy package

of economic measures, with an appropriately set minimum wage in

tandem with in-work bene…ts, is likely, on balance, to be bene…cial in

moving towards an employment-centered social policy.”

2



Contents

1. The impact of minimum wage on employment and inequalities

2. Is the minimum wage an e¢cient way to redistribute income?

3. Minimum wage and the quality of labor relations

3



1. The impact of minimum wage on employment and on

inequalities

1.1 Theory

Perfect competition on the labor market

A minimum wage above the equilibrium wage destroys jobs

4



Figure 1: Labor market with perfect competition

w

L

w wc

Ld

(w)

Ls

(w)

5



In the basic matching model (see E Wasmer Equilibrium search

1), equilibrium labor market tightness is de…ned by

q ()

= y wr + s

decreases with the wage

Steady state unemployment

u = ss + q ()

decreases with

Implies steady state unemployment increases with the minimum wage

6



The monopsony model

A monopsony over a particular segment of the labor market is de…ned

by the presence of a single “buyer” of labor services in that segment

Knowing the labor supply that he or she faces, this buyer a¤ects the

equilibrium wage directly by deciding on his or her volume of hires.

If the labor supply grows as wages rise, the monopsony is given an

incentive to restrict its hires so as to get the bene…t of low wages.

Stigler (1946) had already noted that, in this context, there is a theo-

retical possibility that a wage rise is accompanied by a rise in employ-

ment.

7



L workers; production function F (L).

Labor supply, denoted by Ls(w); is taken to increase with respect to

the wage w:

When the …rm decides to pay wage w, it knows that its level of em-

ployment will be Ls(w); its pro…t is then written:

(w) = F [Ls(w)] wLs(w)

Pro…t maximization yields:

F 0(L) = wh

1 + (1=Lw)i

and L = Ls(w)

L

w= wLs0(w)=Ls(w) designates the wage elasticity of labor supply

8



Figure 1 shows that a rise in the minimum wage can entail an increase

in employment if the minimum wage is lower than the competitive

wage. Conversely, if the minimum wage climbs higher than wc; increases in

the minimum wage destroy jobs

The monopsony model relies on very speci…c assumptions, not neces-

sarily relevant

Is it possible to generalize the conclusions of the monopsony model?

9



Minimum wage, labor market participation, and job search e¤ort

In the basic version of the matching model, a rise in minimum wage

leads necessarily to a reduction in equilibrium employment

But this result overlooks the in‡uence of wages on labor market par-

ticipation and on the job search e¤ort made by the unemployed.

Taking these two elements into account may substantially change the

conclusion derived from the basic model

10



Let us assume that decisions to participate in the labor market re-

sult from a tradeo¤ between being an unemployed job seeker and not

participating. Let H be the cumulative distribution function of the expected utilities

outside the labor market of the entire working-age population.

Individuals whose expected utility outside the labor market is less than

the expected utility of an unemployed person U decide to participatein the labor market: the participation rate is U:

Matching model:

- the wage increases with the bargaining power paramater of

workers

- U reaches a maximum when = () the elasticity of q ()

11



Therefore, the wage that emerges from decentralized equilibrium gives

unemployed persons a maximal expected utility only if the Hosios con-

dition ( = ()) is satis…ed. In consequence, when the bargaining power of workers is too low to

satisfy the Hosios condition ( < ()), an increase in the minimum

wage improves the welfare of the unemployed and increases labor mar-

ket participation.

12



The employment rate is equal to

H (U )(1 u)

Let us denote by w the equilibrium wage when the Hosios condition

is ful…lled.

If wm < w; any increase in the minimum wage increases participation

and the unemployment rate, and has an ambiguous impact a priori on

employment.

On the other hand, if wm w any increase in the minimum wage

entails a decline in labor market participation and an increase in un-

employment, which necessarily leads to a fall in employment

13



Hence, taking participation into account in a matching model allows

us to understand how increases in the minimum wage may be favor-

able to employment for low values of the minimum wage, and becomeunfavorable to employment when the minimum wage is high

Nonetheless, this model does suggest that the unemployment rate nec-

essarily grows with the minimum wage

Such is not always the case if search e¤ort is endogenous (see Cahucand Zylberberg, 2004)

14



The quality of jobs

The minimum wage a¤ects not just employment, but also the kinds of

jobs o¤ered.

From this perspective, it may improve the allocation of resources by

favoring the creation of more productive jobs.

The minimum wage can improve welfare by giving individuals an in-

centive to accumulate human capital, which favors growth (Cahuc and

Michel, 1996)

15



Acemoglu (2001) considers a matching model with good and bad jobs.

- The good jobs have higher productivity, and cost more to create,

than the bad ones.- Wages, which …rms and employees bargain over, are therefore

higher for the good jobs

- Decentralized equilibrium systematically leads to too few good

jobs- A minimum wage can improve welfare thanks to an increase in

the number of good jobs

16



1.2. The impact of the minimum wage in light of empirical

research

Correlations between employment and the minimum wage

A …rst generation of empirical studies adopt a methodology which

consists of bringing out possible correlations between variations in em-

ployment and the minimum wage, while controling for the other factors

that might a¤ect employment.

These studies make use of the temporal evolution of the minimum

wage, as well as di¤erences in its level as between industries and/or

geographical regions.

They generally conclude that the minimum wage has a negligible im-

pact on employment, except perhaps for youth employment.

17



It is clear, however, that causal impact of the minimum wage is not

properly identi…ed

18



Studies based on “natural experiments”

Card and Krueger (1995) have studied the impact of increases in the

minimum wage in New Jersey in 1992 and California in 1988;- Pennsylvania, where the minimum wage did not change, consti-

tutes the control group.

- They use a di¤erence-in-di¤erences estimator, and …nd that after

the minimum wage was raised from $4.25 to $5.05, the level of employ-ment in fast-food establishments in New Jersey rose faster than it did

in Pennsylvania.

-They conclude that an increase in the minimum wage can lead

to an increase in employment when this wage was low to start with,as it was in New Jersey

19



This type of study has been replicated in many places: Neumark and

Wascher, 2009

Find results compatible with the monopsony model

20



The minimum wage and inequality

A rise in the minimum wage has opposite e¤ects on income inequality

- On one hand, the minimum wage allows some people to receivea higher wage, and this favors the reduction of inequality

- On the other, it can also destroy jobs, which leads to reduced

incomes for those who would have been able to …nd a job in the absence

of the minimum wage.

Empirical research generally concludes that the minimum wage makes

it possible to reduce wage inequality (especially in the US)

21



2. Is the minimum wage an e¢cient way to redistribute

income?

The fact that the minimum wage can have bene…cial e¤ects does notconstitute a su¢cient reason to justify its utilization, for there may be

other, more e¢cient ways to achieve the desired goals

In particular, it is possible to use taxes.

In theory, when market equilibrium is ine¢cient, it is possible to de-

sign an “optimal” taxation system that conduces to a socially e¢cient

allocation In practice, though, information asymmetries limit the possibilities of

redistribution: Second best optimum

22



Optimal taxation: the government observes individual incomes, but is

incapable of distinguishing hours from productivity, so taxes can only

depend on income, neither individual hours or productivity: Mirrlees(1971).

In this setting, taxes exert disincentive e¤ects which the government

controls imperfectly, and the minimum wage could play a virtuous part

23



Lee and Saez (2009) have studied the consequence of the minimum

wage in this type of model assuming

- labor supply at the extensive margin (choice between workingand not working)

- agent described by = (!; ), !: productivity when working,

: …xed cost of participating in the labor market

- perfect competition on the labor market They …nd that the minimum wage is useful under the assumption that

workers who involuntary lose their job because of the minimum wageare those with the highest cost of participating in the labor market

24



What is going on when labor markets are monopsonistic? (Cahuc and

Laroque, 2009)

Therefore, monopsonistic competition does not justify the introductionof a minimum wage

25



3. The minimum wage and the quality of labor relations

In a cross-section of countries, the quality of labor relations is

- negatively correlated with the stringency of government regula-tion of minimum wages

- positively correlated with union density

26



Quality of labor relations and state regulation of minimum wage

Aus

Aut

Bg

Cd

DkFin

Fra

Ger

Gre

Ire

Ita

Jp

Nth

Nw

Pt

Sp

Swd

UkUsa

0

. 2

. 4

. 6

S t a t e r e g u l a t i o n o f m i n i m u m w

a g e

3 4 5 6 7Cooperative Labor Relations: Executives

R²=0.46

27



Quality of labor relations and union density

Aus Aut

Bg

Cd

DkFin

Fra

GerGre

Ire

Ita

Jp

Nw

Pt

Sp

Swd

Uk

Usa

0

2 0

4 0

6 0

8 0

U n i o n

d e n s i t y

3 4 5 6 7Cooperative Labor Relations: Executives

R²=0.34

28



State regulation of minimum wage and union density

Aut

Bg

Cd

Czr

DkFin

Fra

GerGre

Hg

IreIta

Jp

Mx

Nth

Nw

Pol

Pt

Sp

Swd

Uk

Usa

- 2 0

0

2

0

4 0

6 0

8 0

U n i o

n i z a t i o n r a t e ( % )

0 .2 .4 .6State regulation of minimum wages

R²=0.55

29



Di¤erent ways to regulate labor markets: either through the state or

through the civil society

Aghion, Algan, Cahuc (2011) documents, and explains, these di¤er-ent labor market regulations and their links with the quality of labor

relations.

30



Explanation:

1. State regulation of minimum wage reduces incentives to unionize and

to invest in the quality of labor relations Model where trade unions might improve productivity by fostering

voice rather than exit in labor relations (Hirshman, 1970, Freeman

and Medo¤, 1984)

When productivity is increased by voice, employers and trade unionscan bargain higher wages

Voice needs speci…c investments in the quality of labor relations to

have a chance of success

31



Investment in the quality of labor relations hinges on

- beliefs about the potential cooperative nature of labor relations

- legal minimum wage (reduces the incentives to invest in thequality of labor relations)

2. Low quality of labor relations induces demand for state regulation

32



Multiple equilibria depending on beliefs about the cooperative nature

of labor relations:

1. Good equilibrium:- high union density and investment in the quality of labor

relations

- high quality of labor relations, low state regulation of wages

2. Bad equilibrium:

- low union density and no investment in the quality of labor

relations

- low quality of labor relations, high state regulation and per-

sistent ideology of class struggles

33



3.1.. Facts on the quality of labor relations, unionization and

state regulation of wages

1.1. Cross country correlations between cooperation and minimum wage

1.2. Cross country di¤erences in the beliefs about the quality of labor

relations

34



3.1.1. Cross country correlations between cooperation and

minimum wage

Data Period 1980-2003

State regulation of minimum wage: composite index.

1. Stringency of the minimum wage legislation (ILO)(statutory, legal

extentions, derogations)

2. Level of the minimum wage (OECD, Neumark and Wascher, 2004)

35



Minimum wage legislation

1. minwage_legal :

= 1 if a statutory minimum wage exists,= 0.5 if union bargaining with extensions= 0 otherwise.

36



minwage_legal. Period: 1980-2003.

0

. 2

. 4

. 6

. 8

1

L e g a l v e r s u s n e g o c i a t e d w a g e f l o o r s

Hg Gre Fra Czr Cd Aus Uk Ita Ger Bg Aut Swd Nw Fin Dk

37



2. minwage_dispersion : degree of dispersion in minimum wages

across ages, quali…cations, regions, sectors or occupations.

2 sub-indexes:

38



- First sub-index: age

= 1 if there is no provision at all for sub-minimum wages

= 0.5 if derogations are restricted to workers younger than 18

years old or if the derogation is less than half the o¢cial minimum wage

= 0 if the derogations can be extended to people older than 18

years or/and if the sub-minimum wages are lower than half the standard

wage ‡oor

39



- Second sub-index: regions, sectors or occupation

= 0 if the minimum wage is allowed to di¤er along at least the

three dimensions of regions, sectors and occupations

= 0.33 if there are two types of distinctions

= 0.67 for one type of distinction

= 1 if no dispersion

minwage _dispersion = average of the 2 sub-indexes

40



minwage_dispersion

0

. 2

. 4

. 6

. 8

1

D i s p e r s i o n

i n w a g e f l o o r s

x Ita Tk Pol Nw Nth Jp Fin Uk Ger Dk Ire Cd Aus Swd

41



minwage _legislation = m inwage _legal minwage _dispersion

42



Minimum wage levels

- ratio of the minimum wage rate over the median wage

- average value for full-time minimum wage workers who are not

subject to any derogations

Composite index of state regulation of minimum wages:

= minwage _legislation minwage _level

43



Quality of labor relations

- “Do you think that labor relations are in general cooperative in your

…rm?”

- Questions to executives (Global Competitiveness Reports) and workers

(ISSP)

Union density: OECD

44



Dependent variable State regulation of minimum wages

Composite

index

(1)

Legal

(2)

Dispersion

(3)

Legal*Level

(4)

Dispersion*Level

(5)

Unionization rate-.518

***

(.083)

-1.568***

(.156)

-.587***

(.134)

-.606***

(.099)

-.214***

(.099)

R2 .441 .658 .262 .442 .102

Observations 58 58 58 58 58

45



Dependent variableState regulation of minimum wages

(Composite index)

(1) (3)

Union density-1.089***

(.312)

Unionization rate (-1)-0.528

**

(.262)

Country …xed e¤ects Yes***

Yes***

Time dummies Yes***

Yes***

Observations 36 36

46



Dependent variable Quality of labor relations (GCR 1999)

(1) (2) (3) (4)

Union density

2.091***

(.716)

2.140**

(.912)

State regulation

of minimum wages

-3.339***

(.876)

-2.821***

(.827)

Unemployment rate-7.301

*

(3.802)

-12.625**

(4.170)

Replacement rate.555

(.941)

.422

(.860)

Bene…t duration-.466

(.570)

.235

(.437)

Employment protection-.098

(.289)

.152

(.259)

Tax wedge-1.810

(1.682)

-.366

(1.052)

R2 .34 .56 .46 .74

47



3.1.2. Beliefs in the quality of labor relations and the de-

mand for state regulation of wages

Beliefs in the quality of labor relations are in‡uenced by past history Beliefs in the quality of labor relations are associated with the demand

for state regulation of wages

Reverse causality In‡uence of country of origins on beliefs of US im-

migrants

General Social Survey database, period 1977-2004

“From what countries or part of the world did your ancestors come

from?”

Second or …rst generation Americans born after 1950

48



Beliefs in the quality of labor relations

“There will always be con‡ict between management and workers be-

cause they are really on opposite sides ”.- Answers: 1: “Strongly agree”, 2: “Agree”, 3: “Disagree”, 4:

“Strongly disagree”.- Ordered to provide an index of Distrustful labor relations .

49



Correlation between US-immigrants’ beliefs in labor con‡icts and the

quality of labor relationships in the home country.

50



Cd

Czr

Dk

Fra

Ger

Ire

Ita

Mx

Nth

Nw

Rus

Sp

Swd

Uk

- . 5

0

. 5

M a n a g e r s a n d W

o r k e r s w i l l a l w a y s b e i n

c o n f l i c t : U S

4 5 6Quality of labor relationship in source country

R²=0.40

51



Beliefs in the quality of labor relations are associated with the demand

for state regulation of wages

“Here are some things the government might do for the economy.Please show which actions you are in favor of and which you are

against: control wages by law? ”.

Answers ranges from 1, for strongly disagree, to 5 for strongly agree.

52



Government should control wages by law

(2) (3) (4)

Quality of labor relations

in home country - Index CGR

-.117***

(.044)

State regulation of minimum

wage in home country

.387***

(.123)

Union density

in home country

-.368*

(.202)N 2087 1777 2087

R2 .038 .043 .036

Ordered probit e¤ects with robust standard errors GSS : ***:1%, **: 5%, *: 10

Additional controls: gender, age, education, income category

53



2. The model

Key ingredients: Theory on policies and dynamics of beliefs

- Model in which cooperative nature of people is unknown- Experimentation and learning process only if people invest in

negotiation

- Multiple equilibria: persistent ideology of class struggles

54



In…nite horizon economy where individuals live one period

Each generation is made of a continuum of measure one of risk neutral

individuals Two non storable goods: a numeraire good and labor

Each individual is endowed with one unit of labor

Individuals di¤er in their ability

In each period t; the proportion of individuals who produce less than

y; y 0; cdf G(y)

G uniform on the interval [0; 1]

55



Utility of an individual paid a wage wt in period t amounts to the wage

wt if he is not unionized and to

vt = wt cif he is unionized, where c 2 (0; 1) denotes the cost of unionization

Workers face a monopsonistic representative …rm

Non unionized workers get the minimum wage wt 0 if their produc-

tivity y is higher than wt and get no job o¤er otherwise

Unionization can allow workers to capture a share of output depending

on the quality of labor relations

56



Quality of labor relations can be high or low

In each period t; the probability of success and failure of bargaining

depends on the quality of labor relations

Pr(bt = S ) =

1 " if high quality

" if low quality

Pr(bt = F ) = 1 " if low quality

" if high qualitywhere " < 1=2

Workers observe the outcome of the bargaining:

- success (bt = S ): wt(y) = y

- failure (bt = F ): wt(y) = wt

57



High quality of labor relations requires a positive investment from

unions:

Investment/Experimentation: it =

I > 00

The payo¤ from investment is uncertain and depends on the coopera-

tive nature of the economy (ex: reaction from the …rm)

True cooperative nature is not observable: e = C or e = N C

q t: subjective beliefs about the cooperative nature of people at date t

People can only infer the true cooperative nature by observing the

success or failure of negotiation Beliefs are updated according to Bayes’ rule: q t depends on the history:

past number of negotiations and past number of successes

58



Sequence of decisions

In each period t, the sequence of decisions is the following:

1. Individuals vote to elect a government on its minimum wage agendawt 0

2. The government sets the minimum wage

3. The union decides whether or not to invest in the quality of labor

relations.

4. Workers decide to join trade unions

5. Wages are set by employers for non unionized workers and by wage

negotiation for unionized workers

The model is solved backward

59



How does the minimum wage a¤ect unionization and beliefs

?

Proceed in 2 steps: Short run equilibrium, with given beliefs q t = Pr [e = C jht(n; s)] and

given wt

Dynamics of beliefs and unionization

60



Short run equilibrium

Union density

- decreases with the minimum wage- increases with the degree of optimism of beliefs

Investment/experimentation decision if

- minimum wage su¢ciently low

- beliefs are su¢ciently optimistic

61



Dynamics of beliefs, unionization and experimentation

Minimum wage is exogenously …xed as some level w 0 for all periods

t 0

Dynamics of experimentations depends on the sequences of successes

and on initial beliefs q 0:

Proposition 1: If the economy is of the cooperative type (e = C )and if q 0 > q; then the economy avoids the no investment/ no exper-imentation trap with probability Q(q 0; w) which is increasing in q 0 and decreasing in w

62



Optimal minimum wage and the di¤erent social regimes

Minimum wage chosen by a utilitarian government

Short-run equilibria

For given beliefs, there exists a threshold value of beliefs ~q such that if

- q t < ~q; the union does not invest and the government sets

wt 1=2

- q t > ~q; the union invests and the government sets

wt < 1=2;

63



Dynamics of beliefs

“French” equilibrium

If initial beliefs are too pessimistic, q 0 = Prt=0 (e = C ) ~q;

! the economy is trapped in a situation with zero investment and

no experimentation forever.

Persistence of the ideology of class struggles in France (see Crouch,

1964 for initial conditions)

The minimum wage is high and union density low

64



“Scandinavian” equilibrium

When initial beliefs are su¢ciently optimistic, i.e. when q 0 > ~q , in-

vestment in period zero is positive, and social experimentation takesplace.

With ex-ante probability P (q 0; ~q ) (which decreases with q 0) the econ-

omy will end up in a “French”

But with probability

1 P (q 0; ~q )

it will converge toward the “Scan-dinavian” steady state.

In the “Scandinavian” steady state, the minimum wage is low and

union density is high

65



Conclusion

The minimum wage has an ambiguous impact on employment and

inequalities. The higher the minimum wage, the higher the chance that it destroys

jobs and increases inequalities

It can be justi…able to use the minimum wage when there are restric-

tions on the set of available tax instruments, so that the minimumwage somehow is a substitute to another missing tool

There is a tradeo¤ between government regulation of the minimum

wage and the quality of labor relations

66



Further readings

Philippe Aghion, Yann Algan and Pierre Cahuc, Can policy interact

with culture? Minimum wage and the quality of labor relations, forth-

coming in the Journal of the European Economic Association, 2011.

Pierre Cahuc and Guy Laroque, 2007, Optimal Taxation and Monop-

sonistic Labor Market: Does Monopsony justify the Minimum Wage?”,

IZA DP No. 2955

David Card and Alan Krueger, 1995, Myth and Measurement: The NewEconomics of the Minimum Wage, Princeton University Press.

David Lee and Emmanuel Saez, 2009, Optimal Minimum Wage Policy

in Competitive Labor Markets, Working paper, University of Berkeley.

David Neumark and William L. Wascher, 2007, Minimum Wages andEmployment, IZA DP No. 2570

67



David Neumark and William L. Wascher, 2009, Minimum Wages, MIT

Press

Georges Stigler, 1946, The Economics of Minimum Wage Legislation,

American Economic Review, 36, 535-543.

68

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