Wage and employment effects of non binding minimum wages
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Wage and employment effects of non-binding minimum wages. Marcus Dittrich Andreas Knabe TU Chemnitz & CESifo FU Berlin & CESifo Social Choice and Welfare Moscow, July 2010. Motivation.

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Wage and employment effects of non binding minimum wages

Wage and employment effects of non-binding minimum wages

Marcus Dittrich Andreas Knabe

TU Chemnitz & CESifo FU Berlin & CESifo

Social Choice and Welfare

Moscow, July 2010


Motivation

Motivation

  • “The effects of the minimum wage on employment and the distribution of income have been hotly debated policy question for over 50 years.“ (Brown 1999)

    • Pro: raising the wages of the lowest-paid would help fighting poverty

    • Contra: introducing such rigidities impedes allocative role of flexible wages, causing more unemployment and possibly even more poverty

  • Oneissuethatmostproponentsandopponentsagree on: MW have to be binding to have any effect!


Motivation spillover effects of mw

Motivation: Spillover effectsofmw

  • But: Many studies report that raising the MW has spillover effects (Katz/Krueger 1992, ILLR; Manning 2003, Neumark et al. 2004, JHR).

  • Two important stylized facts:

    • Firms raise the wages of workers that used to earn less than the new MW above the minimum level required.

    • Workers already earning wages above the new MW receive wage raises as well.

    • Possible explanation: Employers attempt to maintain their internal wage hierarchy.


Motivation spillover effects of mw1

Motivation: Spillover effectsofmw

match if firm‘s offer ≥ res. wage

Experimental evidence (Falk et al. 2006, QJE)

  • excludes wage hierarchy effects or effort considerations

  • similar to “ultimatum game”

    • firm proposes a wage

    • worker sets reservation wage

  • main finding: introduction of MW increases wages above the new minimum, because it drives up reservation wages

  • Potential explanation: MW affects what people consider to be a ”fair” compensation for their work.

  • How can these findings be explained by theoretical models?


  • Outline

    Outline

    • Motivation: spillover effects of MW

    • Model economy

    • Nash wage bargaining

    • Kalai-Smorodinsky wage bargaining

    • Conclusion


    Model economy

    Model economy

    • economy with large number of sectors

    • bargaining over wages (w ) between unions and firms

    • representative firm’s profit:

    • representative union’s utility:

    • alternative income:


    Nash wage bargaining

    Nash wage bargaining

    Nash bargainingsolutionfollowsfromfouraxioms (Nash 1950,Econometrica):

    • Pareto efficiency

    • Invariance to equivalent utility representations

    • Symmetry

    • Independence of irrelevant alternatives


    Nash wage bargaining1

    Nash wage bargaining

    • Nash bargaining solution:

      where = player i ’s utility, = conflict utility, S = utility possibility set

    • applied to wage bargaining problem:


    Nash wage bargaining2

    Nash wage bargaining


    Nash wage bargaining3

    Nash wage bargaining


    Nash wage bargaining4

    Nash wage bargaining

    What do non-binding MW do?

    1. sectoral level

    • w0 exogenous

       Sectoral MW has no effect on bargained wage.


    Nash wage bargaining5

    Nash wage bargaining


    Nash wage bargaining6

    Nash wage bargaining

    What do non-binding MW do?

    1. sectoral level

    • w0 exogenous

       Sectoral MW has no effect on bargained wage if it is non-binding.

      2. national level

    •  no change in any wages

    • hence, w0 unchanged

       National MW has no effect on bargained wage if it is non-binding.


    Kalai smorodinsky wage bargaining

    Kalai-Smorodinsky wage bargaining

    alternative axiomatic solution (Kalai/Smorodinsky 1975, Econometrica)

    maintain first three axioms of Nash solution

    replaces IIA with “individual monotonicity” axiom

     a player must not suffer from an enlargement of the bargaining set that leaves the maximum utility attainable by the other player unchanged


    Kalai smorodinsky wage bargaining1

    Kalai-Smorodinsky wage bargaining

    • both bargaining parties agree to a solution that equalizes the relative utility gains ( ratio of the actual gains to the maximum feasible gains)

    • maximum feasible gain is determined by the payoff one can secure by pushing the other party to the minimum payoff it would just be willing to accept

    • could be interpreted as “fairness” (McDonald / Solow 1981, AER)  if a player could have more (without hurting the other player), he should have more


    Kalai smorodinsky wage bargaining2

    Kalai-Smorodinsky wage bargaining

    • general KS solution: both parties make equal proportional concessions from their respective favored points  KS curve:

    • applied to wage bargaining problem:


    Kalai smorodinsky wage bargaining3

    Kalai-Smorodinsky wage bargaining

    • “utopia points”:

    • bargained wage:


    Kalai smorodinsky wage bargaining4

    Kalai-Smorodinsky wage bargaining


    Kalai smorodinsky wage bargaining5

    Kalai-Smorodinsky wage bargaining

    What do non-binding MW do?

    •  change in utopia point:

    • KS curve:

    • bargained wage:


    Kalai smorodinsky wage bargaining6

    Kalai-Smorodinsky wage bargaining

    What do non-binding MW do?

    1. sectoral level

    • w0 exogenous

    • bargained wage raises to a level above the former wage

    • implication: MW is non-binding, but effective!

       Sectoral MW reduces the firm‘s utopia payoff and hence drives up the wage.


    Kalai smorodinsky wage bargaining7

    Kalai-Smorodinsky wage bargaining


    Kalai smorodinsky wage bargaining8

    Kalai-Smorodinsky wage bargaining

    What do non-binding MW do?

    1. sectoral level

    • w0 exogenous

       Sectoral MWreduces the firm‘s utopia payoff and hence drives up the wage.

      2. national level

    • direct effect in each sector if

    • plus: changes in w0 affect wages in other sectors

       National MW does not have to be binding, but is effective


    Conclusion

    Conclusion

    • Empirical evidence suggests that MW have real effects even if they are not binding.

    • Implications for economic theory:

      KS solution is able to describe these effects, Nash solution is not.

    • Implications for public policy:

      Even relatively low MW might have negative employment effects  policy implications depend on whether union-firm-bargaining follows Nash or KS solution.


    Wage and employment effects of non binding minimum wages

    Thank you very much!


    Motivation spillover effects of mw2

    Motivation: Spillover effectsofmw

    Empiricalevidence

    • Katz and Krueger (1992, ILRR): Texan fast-food restaurants

      • one-third “maintained their wage hierarchy” (workers who earned more than the old MW will also earn more than the new minimum)

      • 60% of restaurants who had starting wages already above new minimum still increased their wages

      • Manning (2003): US data 1979-2000

        • spillovers for wages up to 150% of the MW

      • Neumark et al. (2004, JHR): US data 1979-1997

      • spillovers for wages up to twice the MW


    Motivation spillover effects of mw3

    Motivation: Spillover effectsofmw

    • Three popular theoretical explanations

      • Substitution effects (Pettengill 1981)

        • increase in demand for above-minimum wage workers raises their wages, too

      • Monopsonistic firm behavior (Manning 2003)

        • some firms pay high wages to attract workers from low-wage firms

        • if low-wage firms pay more, also high-wage firms have to raise their wages

      • Efficiency wages (Grossman 1983, JHR)

        • smaller wage differential between skilled and unskilled workers has to be compensated to keep up effort of skilled workers


    Experimental evidence

    Experimental evidence

    • Falk, Fehr & Zehnder (2006, QJE) conduct a laboratory experiment in which a rent is distributed between “workers” and a “firm”.

    • In the experiment’s first step, workers state their reservation wages, which are not observed by the firm.

    • Then, the firm makes a wage offer and workers with reservation wages below this wage offer are hired.


    Experimental evidence1

    Experimental evidence

    • The introduction of a minimum wage raises workers’ reservation wages: Before its introduction, 91% of workers stated a reservation wage below the later minimum wage.

    • After it had been introduced, 59% reported that their reservation wage was equal to the new minimum wage, and the other 41% said that their reservation wage was even larger than the new minimum wage.

    • Result: minimum wages affect the wage level that people are willing to accept even if they are not directly affected by the new minimum wage.


    Model economy monopoly union

    Model economy: monopolyunion

    • reference scenario: monopolistic union sets the wage, firms set employment

    • monopoly union behavior:


    Model economy monopoly union1

    Model economy: monopolyunion


    Model economy monopoly union2

    Model economy: monopolyunion


    Model economy monopoly union mw

    Model economy: Monopoly union & MW

    What do non-binding MW do?

    1. sectoral level

    • w0 exogenous

       Sectoral MW has no effect on monopoly union‘s desired wage.


    Model economy monopoly union mw1

    Model economy: Monopoly union & MW


    Model economy monopoly union mw2

    Model economy: Monopoly union & MW

    What do non-binding MW do?

    1. sectoral level

    • w0 exogenous

       Sectoral MW has no effect on monopoly union‘s desired wage.

      2. national level

    •  no change in wages

    • w0 unchanged

       National MW has no effect on monopoly union‘s desired wage if it is non-binding.


    Nash s axioms

    Nash‘saxioms

    Find a bargaining solution that satisfies the following four axioms:

    • Pareto efficiency(PAR)

    • Invariance to equivalent utility representations (INV)

    • Symmetry (SYM): symmetric utility functions should ensure symmetric payoffs

    • Independence of irrelevant alternatives (IIA):

      If S is the Nash bargaining solution for a bargaining set X, then for any subset Y of X containing S, S continues to be the Nash bargaining solution.


    Ks s axioms

    KS‘saxioms

    Find a bargaining solution that satisfies the following four axioms:

    • Pareto efficiency (PAR)

    • Invariance to equivalent utility representations (INV)

    • Symmetry (SYM): symmetric utility functions should ensuresymmetricpayoffs

    • Individual monotonicity (MON):

      If the bargaining set is enlarged such that the maximum utilities of the players remain unchanged, then neither of the players must not suffer from it.


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