The turnover-reducing effects of minimum wage hikes might be undesirable

I have just uploaded a new working paper. Although this one is not about economic history, it does concern an issue I have to deal very often in economic history: wages and price controls.

In this working paper, I decided to tackle the issue of the minimum wage and the empirical finding whereby there are only small or even insignificant negative effects on employment from hikes in the minimum. The argument generally advanced is that the minimum wage actually solves a coordination failure. Since there are important search costs for employees and employers and important costs in training and firing, a large number of differing wage rates for unskilled workers creates a coordination failure where there are numerous unfilled vacancies and high turnover. In the presence of a minimum wage, these frictions are minimized and there are gains in employment. At least, that is the argument.

For the sake of argument, I decide to accept the empirical finding of the absence of discernible effects on employment resulting from minimum wage hikes. I argue that, if the relation between turnover and productivity is not linear, the effects of the minimum wage will be observed on productivity rather than employment.

As time passes, an unskilled worker acquires some forms of human capital through experience and soft skills. Once he has accumulated this human capital, he becomes more attractive for all firms. However, some firms might be better matches for this employee than other firms. Productivity is only optimized if this worker is matched with the employers who value him the most. Normally, employers would attract this worker by offering higher wages with the highest wage offer representing the best potential match between this employee and employer. The high wage rate, commensurate with skills and experience acquired, would incite a higher turnover in the sector with unskilled workers. However, the minimum wage increases the threshold of wage offers that other sectors must surpass to incite the employees of the first sector to change employer. Thus, the minimum wage creates a coordination failure leading to labor misallocation that generates suboptimal productivity.

In short, the argument that the minimum has small negative effects on employment does not mean that there are small overall effects on the economy. Defenders of minimum wage hikes must not rejoice at their finding as the mountain they must climb is still dangerous.

Full paper : HERE 


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