MINIMUM WAGE LAWS

Minimum wage laws

Abstract

Card and Krueger find empirically that minimum wage laws may increase employment. The current paper seeks the analytical implications of employment-increasing minimum wages for output and welfare. The standard supply and demand model cannot be used for this purpose. One needs a model in which employment-increasing minimum wages are at least possible, such as this paper's efficiency wage model. Here, an employment increase is neither necessary nor sufficient for expected welfare gains for either employed or unemployed workers. An employment-increasing minimum wage raises output but unambiguously lowers labor force participation and hurts those who remain unemployed.

Minimum wage laws: what does an employment increase imply about output and welfare?

Introduction

Recently several authors, most notably Card and Krueger (1995), have found that minimum wage laws may raise employment. This provocative and controversial2 result is often viewed as providing a justification for higher minimum wages. Yet, how do we know that more employment means more welfare?

The standard textbook discussion of minimum wage laws uses the supply and demand model. In that model, the main disadvantage of minimum wages is that employment falls. This causes the policy to be inefficient and output-reducing. Even in more advanced discussions which recognize other effects, economists still often concentrate on employment; see Gramlich (1976) or Brown et al. (1982). It is therefore not surprising that the results of Card and Krueger are seen as so important. Thinking in terms of the textbook model, these results suggest that minimum wage laws may have no efficiency cost.

But, the textbook model is inappropriate to use here. Employment cannot increase in the textbook model. Clearly, one cannot analyze the welfare implications of a result using a model in which that result is impossible. The only reasonable models to use in studying the welfare effects of employment-increasing minimum wage laws would be ones in which employment increases are at least possible.

This is not a minor issue. Although one might think the relationship between employment and output or worker welfare is obviously positive, this is simply wrong once one leaves the textbook model. To see this, consider some results of efficiency wage models. Drazen (1986) and Perri (1990) show that in one efficiency wage model, a minimum wage law lowers employment but also is Pareto-improving. Carter (1995) finds in a moral hazard model, that for any policy to raise output and welfare, it must lower employment; that is, all employment-increasing policies unambiguously lower output. The same result appears in a model of costly labor turnover in Carter (1993). These results show that the positive relationship between employment and welfare or output is at best questionable.

Now, which models would be appropriate for the current discussion; which models allow for employment-increasing minimum wages? One class may be called 'monopsony-like' models. Here, more employment in a firm implies higher wages in the firm. In the standard monopsony model, the cost rises because the supply curve of labor to the firm is upward sloping; see Stigler (1946), Brown et ...