Labor Economics:

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

March 2010
The minimum wage
Popular justication 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 inuence 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 benets, is likely, on balance, to be benecial 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 ecient 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
L
w w
c
L
d
(w)
L
s
(w)
5
In the basic matching model (see E Wasmer Equilibrium search
1), equilibrium labor market tightness is dened by

(o)
=
n
: + :
o decreases with the wage
Steady state unemployment
n =
:
: + o(o)
decreases with o
Implies steady state unemployment increases with the minimum wage
6
The monopsony model
A monopsony over a particular segment of the labor market is dened
by the presence of a single buyer of labor services in that segment
Knowing the labor supply that he or she faces, this buyer aects 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 benet 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
1 workers; production function 1(1).
Labor supply, denoted by 1
:
(n). is taken to increase with respect to
the wage n.
When the rm decides to pay wage n, it knows that its level of em-
ployment will be 1
:
(n); its prot is then written:
(n) = 1[1
:
(n)] n1
:
(n)
Prot maximization yields:
1
/
(1
+
) = n
+
h
1 + (1,j
1
n
)
i
and 1
+
= 1
:
(n
+
)
j
1
n
= n1
:/
(n),1
:
(n) 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 n
c
. increases in
the minimum wage destroy jobs
The monopsony model relies on very specic 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 eort
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 inuence of wages on labor market par-
ticipation and on the job search eort 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 l decide to participate
in the labor market: the participation rate is l.
Matching model:
- the wage increases with , the bargaining power paramater of
workers
- l reaches a maximum when , = j(o) the elasticity of (o)
11
Therefore, the wage that emerges from decentralized equilibrium gives
unemployed persons a maximal expected utility only if the Hosios con-
dition (, = j(o)) is satised.
In consequence, when the bargaining power of workers is too low to
satisfy the Hosios condition (, < j(o)), 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(l)(1 n)
Let us denote by n
+
the equilibrium wage when the Hosios condition
is fullled.
If n
:
< n
+
. any increase in the minimumwage increases participation
and the unemployment rate, and has an ambiguous impact a priori on
employment.
On the other hand, if n
:
_ n
+
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 become
unfavorable 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 eort is endogenous (see Cahuc
and Zylberberg, 2004)
14
The quality of jobs
The minimum wage aects not just employment, but also the kinds of
jobs oered.
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 minimumwage, while controling for the other factors
that might aect employment.
These studies make use of the temporal evolution of the minimum
wage, as well as dierences 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 identied
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 dierence-in-dierences estimator, and nd that after
the minimumwage 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 eects on income inequality
- On one hand, the minimum wage allows some people to receive
a 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 ecient way to redistribute
income?
The fact that the minimum wage can have benecial eects does not
constitute a sucient reason to justify its utilization, for there may be
other, more ecient ways to achieve the desired goals
In particular, it is possible to use taxes.
In theory, when market equilibrium is inecient, it is possible to de-
sign an optimal taxation system that conduces to a socially ecient
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 eects which the government
controls imperfectly, and the minimumwage 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 working
and not working)
- agent described by o = (.. c), .: productivity when working,
c: 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 wage
are 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 introduction
of 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
Dk Fin
Fra
Ger
Gre
Ire
Ita
Jp
Nth
Nw
Pt
Sp
Swd
Uk
Usa
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 7
Cooperative Labor Relations: Executives
R=0.46
27
Quality of labor relations and union density
Aus
Aut
Bg
Cd
Dk Fin
Fra
Ger
Gre
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 7
Cooperative Labor Relations: Executives
R=0.34
28
State regulation of minimum wage and union density
Aut
Bg
Cd
Czr
Dk
Fin
Fra
Ger
Gre
Hg
Ire
Ita
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 .6
State regulation of minimum wages
R=0.55
29
Dierent ways to regulate labor markets: either through the state or
through the civil society
Aghion, Algan, Cahuc (2011) documents, and explains, these dier-
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 unions
can bargain higher wages
Voice needs specic 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 the
quality 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 minimumwage
1.2. Cross country dierences 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
Usa Tk Sp Pt Pol Nth Mx Jp Ire 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, qualications, 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 ocial 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 dier 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
Hg Fra Pt Gre Aut Usa Sp Czr Bg Mx Ita Tk Pol Nw Nth Jp Fin Uk Ger Dk Ire Cd Aus Swd
41
minwage_legislation = minwage_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)
R
2
.441 .658 .262 .442 .102
Observations 58 58 58 58 58
45
Dependent variable
State regulation of minimum wages
(Composite index)
(1) (3)
Union density
-1.089
***
(.312)
Unionization rate (-1)
-0.528
**
(.262)
Country xed eects 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)
Benet duration
-.466
(.570)
.235
(.437)
Employment protection
-.098
(.289)
.152
(.259)
Tax wedge
-1.810
(1.682)
-.366
(1.052)
R
2
.34 .56 .46 .74
Observations 18 18 18 18
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 inuenced by past history
Beliefs in the quality of labor relations are associated with the demand
for state regulation of wages
Reverse causality Inuence 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 conict 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 conicts 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 6
Quality of labor relationship in source country
R=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
R
2
.038 .043 .036
Ordered probit eects 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
Innite 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 dier in their ability
In each period t. the proportion of individuals who produce less than
. _ 0. cdf G()
G uniform on the interval [0. 1]
55
Utility of an individual paid a wage n
t
in period t amounts to the wage
n
t
if he is not unionized and to

t
= n
t
c
if he is unionized, where c (0. 1) denotes the cost of unionization
Workers face a monopsonistic representative rm
Non unionized workers get the minimum wage n
t
_ 0 if their produc-
tivity is higher than n
t
and get no job oer otherwise
Unionization can allowworkers 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(/
t
= o) =

1 if high quality
if low quality
Pr(/
t
= 1) =

1 if low quality
if high quality
where < 1,2
Workers observe the outcome of the bargaining:
- success (/
t
= o): n
t
() =
- failure (/
t
= 1): n
t
() = n
t
57
High quality of labor relations requires a positive investment from
unions:
Investment/Experimentation: i
t
=

1 0
0
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: c = C or c = `C

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:
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 agenda
n
t
_ 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 aect unionization and beliefs
?
Proceed in 2 steps:
Short run equilibrium, with given beliefs
t
= Pr [c = C[/
t
(:. :)] and
given n
t
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 suciently low
- beliefs are suciently optimistic
61
Dynamics of beliefs, unionization and experimentation
Minimumwage is exogenously xed as some level n _ 0 for all periods
t _ 0
Dynamics of experimentations depends on the sequences of successes
and on initial beliefs
0
.
Proposition 1: If the economy is of the cooperative type (c = C)
and if
0
. then the economy avoids the no investment/ no exper-
imentation trap with probability Q(
0
. n) which is increasing in
0
and
decreasing in n
62
Optimal minimum wage and the dierent social regimes
Minimum wage chosen by a utilitarian government
Short-run equilibria
For given beliefs, there exists a threshold value of beliefs ~ such that if
-
t
< ~ . the union does not invest and the government sets
n
t
_ 1,2
-
t
~ . the union invests and the government sets
n
t
< 1,2.
63
Dynamics of beliefs
French equilibrium
If initial beliefs are too pessimistic,
0
= Pr
t=0
(c = C) _ ~ .
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 suciently optimistic, i.e. when
0
~ , in-
vestment in period zero is positive, and social experimentation takes
place.
With ex-ante probability

1(
0
. ~ ) (which decreases with
0
) the econ-
omy will end up in a French
But with probability

1

1(
0
. ~ )

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 justiable to use the minimum wage when there are restric-
tions on the set of available tax instruments, so that the minimum
wage 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 New
Economics 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 and
Employment, 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