Wage and employment effects of non-binding minimum wages

1
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

2
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
• One issue that most proponents and opponents
  agree on MW have to be binding to have any
  effect!

3
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
• 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.

4
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?

match if firms offer res. wage
5
Outline

• Motivation spillover effects of MW
• Model economy
• Nash wage bargaining
• Kalai-Smorodinsky wage bargaining
• Conclusion

6
Model economy

• economy with large number of sectors
• bargaining over wages (w ) between unions and
  firms
• representative firms profit
• representative unions utility
• alternative income

7
Nash wage bargaining

• Nash bargaining solution follows from four axioms
  (Nash 1950, Econometrica)
• Pareto efficiency
• Invariance to equivalent utility representations
• Symmetry
• Independence of irrelevant alternatives

8
Nash wage bargaining

• Nash bargaining solution
• where player i s utility, conflict
  utility, S utility possibility set
• applied to wage bargaining problem

9
Nash wage bargaining
10
Nash wage bargaining
11
Nash wage bargaining

• What do non-binding MW do?
• 1. sectoral level
• w0 exogenous
• ? Sectoral MW has no effect on bargained wage.

12
Nash wage bargaining
13
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.

14
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

15
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

16
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

17
Kalai-Smorodinsky wage bargaining

• utopia points
• bargained wage

18
Kalai-Smorodinsky wage bargaining
19
Kalai-Smorodinsky wage bargaining

• What do non-binding MW do?
• ? change in utopia point
• KS curve
• bargained wage

20
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 firms utopia payoff
  and hence drives up the wage.

21
Kalai-Smorodinsky wage bargaining
22
Kalai-Smorodinsky wage bargaining

• What do non-binding MW do?
• 1. sectoral level
• w0 exogenous
• ? Sectoral MWreduces the firms 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

23
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.

24

• Thank you very much!

25
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

26
Motivation Spillover effects of mw

• 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

27
Experimental evidence

• Falk, Fehr Zehnder (2006, QJE) conduct a
  laboratory experiment in which a rent is
  distributed between workers and a firm.
• In the experiments 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.

28
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.

29
Model economy monopoly union

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

30
Model economy monopoly union
31
Model economy monopoly union
32
Model economy Monopoly union MW

• What do non-binding MW do?
• 1. sectoral level
• w0 exogenous
• ? Sectoral MW has no effect on monopoly unions
  desired wage.

33
Model economy Monopoly union MW
34
Model economy Monopoly union MW

• What do non-binding MW do?
• 1. sectoral level
• w0 exogenous
• ? Sectoral MW has no effect on monopoly unions
  desired wage.
• 2. national level
• ? no change in wages
• w0 unchanged
• ? National MW has no effect on monopoly unions
  desired wage if it is non-binding.

35
Nashs 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
• 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.

36
KSs 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.