wage and employment effects of non-binding minimum wages

36
MARCUS DITTRICH 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

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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. - PowerPoint PPT Presentation

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Page 1: Wage and employment effects  of non-binding minimum wages

MARCUS DITTRICH

Wage and employment effects

of non-binding minimum wages

Marcus Dittrich Andreas Knabe

TU Chemnitz & CESifo FU Berlin & CESifo

Social Choice and WelfareMoscow, July 2010

Page 2: Wage and employment effects  of non-binding minimum wages

MARCUS DITTRICH

2

• “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

• One issue that most proponents and opponents agree on: MW have to be binding to have any effect!

MOTIVATION

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MARCUS DITTRICH

MOTIVATION: SPILLOVER EFFECTS OF MW

• 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:1. Firms raise the wages of workers that used to

earn less than the new MW above the minimum level required.

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

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

3

Page 4: Wage and employment effects  of non-binding minimum wages

MARCUS DITTRICH

MOTIVATION: SPILLOVER EFFECTS OF MW

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?

4

match if firm‘s offer ≥ res. wage

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1. Motivation: spillover effects of MW

2. Model economy

3. Nash wage bargaining

4. Kalai-Smorodinsky wage bargaining

5. Conclusion

OUTLINE

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• economy with large number of sectors• bargaining over wages (w ) between unions

and firms• representative firm’s profit:

• representative union’s utility:

• alternative income:

1

1ww L wL L

MODEL ECONOMY

0 1w ub u w

0 , with V w wL N L w L N

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MARCUS DITTRICH

NASH WAGE BARGAINING

Nash bargaining solution follows from four axioms (Nash 1950, Econometrica):1. Pareto efficiency2. Invariance to equivalent utility representations3. Symmetry4. Independence of irrelevant alternatives

7

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• Nash bargaining solution:

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

• applied to wage bargaining problem:

1

1

0

0

max s.t.

1

2

w

Nash

wV w V w L

w w

1 21 1 2 2

,max( ) ( )v v S

v d v d

ivid

NASH WAGE BARGAINING

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MARCUS DITTRICH

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NASH WAGE BARGAINING

V

V 0

V w( )m on

( )w m on

L w N( )=

V ( ( ) )

A

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MARCUS DITTRICH

NASH WAGE BARGAINING

10

V

B

C

A

const.

V0

V w( )Nash

( )wNash

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MARCUS DITTRICH

NASH WAGE BARGAINING

What do non-binding MW do?1. sectoral level•

• w0 exogenous

Sectoral MW has no effect on bargained wage.

11

min Nashw w

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MARCUS DITTRICH

NASH WAGE BARGAINING

12

V

B

C

A

const.

V0

V w( )Nash

( )wNash ( )wmin

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MARCUS DITTRICH

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.

13

min Nashiw w i

min Nashw w

Page 14: Wage and employment effects  of non-binding minimum wages

MARCUS DITTRICH

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

14

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• 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 BARGAINING

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

• applied to wage bargaining problem:

1 1 2 2* *1 1 2 2

v d v d

v d v d

1 1 0( ),v V w d V

2 2( ), 0v w d

KALAI-SMORODINSKY WAGE BARGAINING

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• “utopia points”:

• bargained wage:

*1 arg max ( ) s.t. 0

wv V w

*2 0arg max ( ) s.t.

wv w V V

0

0 0 00

01

( ) ( )

( )( )

1 1

mon mon

KS

L w w w L w wL w

L w w L wL w w w

ww

KALAI-SMORODINSKY WAGE BARGAINING

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MARCUS DITTRICH

KALAI-SMORODINSKY WAGE BARGAINING

18

V

D

A utopiapoint

V0

V *

V w( )KS

( )wKS ( )w0

C

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What do non-binding MW do? • change in utopia point:

• KS curve:

• bargained wage:

*2 0arg max ( ) s.t. min

wv w w w w

KALAI-SMORODINSKY WAGE BARGAINING

0minw w

0

0

( ) ( )

( ) ( )mon mon min min min

L w w w L w wL w

L w w w L w w L w

0

1

01 1

KS

min

ww

w w

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MARCUS DITTRICH

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.

20

0, butmin KS minw w w w

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MARCUS DITTRICH

KALAI-SMORODINSKY WAGE BARGAINING

21

V

C

D

E

utopiapoint

V0

( )wmin ( )w0

A

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MARCUS DITTRICH

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

22

0, butmin KS minw w w w

0minw w

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• 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.

CONCLUSION

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Thank you very much!

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MARCUS DITTRICH

MOTIVATION: SPILLOVER EFFECTS OF MW

Empirical evidence• 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

25

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MARCUS DITTRICH

MOTIVATION: SPILLOVER EFFECTS OF MW

• Three popular theoretical explanations

1. Substitution effects (Pettengill 1981)• increase in demand for above-minimum wage workers raises

their wages, too

2. 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

3. Efficiency wages (Grossman 1983, JHR)• smaller wage differential between skilled and unskilled

workers has to be compensated to keep up effort of skilled workers

26

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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.

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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.

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

• monopoly union behavior:

1

1

0max s.t.w

wV w wL N L w L

0mon ww

MODEL ECONOMY: MONOPOLY UNION

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MODEL ECONOMY: MONOPOLY UNION

w

V( )w

0L

wmon

Lmon

w0

L w( )0

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MODEL ECONOMY: MONOPOLY UNION

V

V0

V w( )mon

( )wmon

L w N( )=

V( ( ))

A

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MARCUS DITTRICH

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.

32

min monw w

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MARCUS DITTRICH

MODEL ECONOMY: MONOPOLY UNION & MW

33

V

V0

V w( )mon

( )wmon

L w N( )=

A

( )wmin

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MARCUS DITTRICH

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.

34

min moniw w i

min monw w

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NASH‘S AXIOMS

Find a bargaining solution that satisfies the following four axioms:

1. Pareto efficiency (PAR)2. Invariance to equivalent utility representations

(INV)3. Symmetry (SYM): symmetric utility functions should

ensure symmetric payoffs4. 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.

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KS‘S AXIOMS

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• 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.