442. The effect of a minimum wage on unemployment in a model of team production.

Paul Frijters, School of Economics Discussion Paper No. 442 1998, School of Economics, The University of Queensland. Australia.

Full text available as:
PDF - Requires Adobe Acrobat Reader or other PDF viewer.

Abstract

To summarise the arguments in this paper, a case will be made for and against an increase in the minimum wage. First the case for the defence of a minimum wage increase. An increase in a minimum wage will, if the increase is within bounds, only increase the percentage of the output that low-skilled workers receive, without altering their employment numbers. If the marginal utility of income decreases with income, a minimum wage will thus increase social welfare in the short term. In the short term it is even possible that the reduction in the wages of the high-skilled workers will increase the labour supply of the high-skilled workers, thereby increasing employment of low-skilled workers and output in the short run. As to the long run: because low-skilled workers are in practice not able to borrow against future wages, a higher minimum wage may increase the education that low-skilled workers are able to afford for 19 themselves and their children, thereby increasing the number of high-skilled workers. This will increase total output in the long run. If there is a long run negative effect of a higher minimum wage on the number of low-skilled jobs, this will increase the incentives of low-skilled workers to become high-skilled, increasing output even further in the long run. Empirically, this possibility does not conflict with the findings that individual low-skilled workers increase their labour supply and their employment prospects if benefits are lowered, or that labour demand for low-skilled workers, in any particular firm or industry, decreases if the wages of the low-skilled workers increases. These are all the effect of the fact that high-skilled workers will move to those firms and industries where they can earn higher wages and will try and combine with those low-skilled workers who will accept the lowest wages. An economy-wide minimum wage will make this ”fleeing” behaviour impossible. The empirical evidence for this view comes from case studies which suggest that an increase in the minimum wage does not lead to a substantial reduction in the number of employed workers in the short run. Now the case against an increase of the minimum wage. If a large increase in the minimum wage crosses a technological ”switching point”, where an existing alternative team technology becomes optimal for the high-skilled workers, the number of low-skilled workers employed will decrease dramatically. As this technology is not used before the increase of the minimum wage, there is no way to empirically tell beforehand whether such a technological switching point will be crossed or not. Even in the short run therefore, an increase in the minimum wage may unexpectedly result in a large reduction in the employment levels of low-skilled workers. In the longer run, the increased incentives for high-skilled workers to find technologies that reduce the number of low-skilled jobs in production, may reduce the long run demand for low-skilled jobs. This may explain why the US and European case studies find such a small effect of a change in the minimum wage: as it takes time to develop and implement new technologies, the effects of a minimum wage under team production will only be felt in the long run. Also, the increase in a minimum wage may reduce the incentives for low-skilled workers to become high-skilled, increasing the number of low-skilled workers and hence reducing output in the long run. A final possibility is that an increase in the minimum wage decreases the wage of high-skilled workers and reduces the labour supply of high-skilled workers, thereby reducing the demand for low-skilled workers, even in the short run11 . Both cases make arguments about what happens to technology and the number of low-skilled workers in the long run, as a result of a higher minimum wage. As it is virtually impossible in an empirical study to separate the long-run effects of a minimum wage on employment and transition probabilities, from all the other factors that influence employment levels and transition probabilities (business cycles, technology shocks, changes in the international competitive environment, government intervention in education markets, etc.), I have little hope that either of these cases can be proven convincingly.