The Behavioral Effects of Minimum Wages

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The Behavioral Effects of Minimum Wages

• Armin Falk (University of Bonn)
• Ernst Fehr (University of Zurich
• Christian Zehnder (University of Lausanne)

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Why studying Minimum Wages?

• Minimum wage laws are an important labor market
  instrument
• 25 of 29 OECD countries have some form of minimum
  wage legislation
• The behavioral effects of minimum wages are still
  not fully understood
• Anomalously low utilization of opportunities to
  pay subminimum wages for certain categories of
  workers (Katz and Krueger 1991, 1992)

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• Spillover effect firms often raise wages of
  workers who earned less than the new minimum wage
  above the level of the new minimum wage (Katz and
  Krueger 1992, Card and Krueger 1994)
• Contested employment effects of minimum wages
  Card (1992), Card Krueger (1994), Machin
  Manning (1994)
• Important for policy evaluation
• Important for the question whether labor markets
  are imperfectly competitive or approximate the
  competitive ideal.

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Main Message I

• Minimum wages have a direct impact on workers
  perception of what constitutes a fair wage and
  thus affect reservation wages
• Introducing a MW increases reservation wages
• Therefore, a sizeable share of workers who earned
  less than the MW before the introduction is paid
  more than the MW after the introduction
• Explains the spillover effect

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Main Message II

• The introduction and the removal of MW has
  asymmetric effects on reservation wages
• Introduction strong rise in reservation wages
• Removal Small decrease in reservation wages
• ? Asymmetric effects on actual wages
• Actual wages strongly increase after introduction
  of MW but only weakly decrease after removal of
  MW
• Explains the low utilization of opportunities to
  pay subminimum wages

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Main Message III

• ? Asymmetric effects on employment
• Actual employment increases after introduction
  but does not decrease after removal of the MW
• Sheds light on the sources of positive employment
  effects

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Minimum Wage Reservation Wages

• For some time economists speculated that minimum
  wages might affect reservation wages
• The minimum wage becomes a focal point,
  representing the going, or acceptable wage. ....
  workers perceive the minimum as the 'fair wage.
  In this way the minimum wage might influence
  workers reservation wages. (Card and Krueger
  95)
• However, reservation wages are difficult to
  measure in field data

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Why a laboratory experiment?

• Empirical evidence for zero or positive
  employment effects highly contested (e.g. Neumark
  and Wascher).
• Measurement errors regarding employment and
  wages.
• Important determinants of employment and wages
  are unobservable or very difficult to observe.
• marginal revenue product of labor (labor demand)
• workers reservation wages (labor supply)
• wage setting mechanism
• Information conditions unknown in the field
• what do firms and workers know about marginal
  revenue product, average product, profits and
  reservations wages.
• Unknown interactions between MW, labor demand or
  supply may occur.

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In a Laboratory Experiment

• no measurement error with regard to wages and
  employment
• perfect knowledge of marginal revenue product
• precise measurement of reservation wages possible
• control over information conditions.

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Experimental Game

• Market Participants
• 6 Firms
• 18 Workers
• Exogenous Matching
• At the beginning of a period each firm is
  randomly matched with three workers
• Stage 1 of a period
• Firms can offer the same wage to 0, 1, 2 or 3
  workers, w ? 0, 1000
• Stage 2 of a period
• Workers simultaneously accept or reject the offer
  they received

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Design continued

• Two Treatments
• Without minimum wage (NO)
• With minimum wage (MW)
• Each treatment lasts 15 periods
• Two Treatment Orders
• Introduction of MW (NO/MW) 5 Sessions
• Elimination of MW (MW/NO) 5 Sessions

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Design continued
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Design continued

• Firms payoff
• Revenue wage ? employed workers
• Workers payoff
• Wage if employed, zero otherwise
• Minimum wage equals 220 lt MRP of third employed
  worker
• Information conditions
• MRP, payoff functions, number of workers and
  firms and the matching technology are common
  knowledge
• Firms are informed about how many workers
  accepted their offer
• Workers are informed about firms profits

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Elicitation of reservation wages

• Ask workers for their acceptance thresholds r
  before they know the wage offer
• If w gt r the offer is accepted, if w lt r it is
  rejected
• ? Supply Schedule observable

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Matching technology

• If acceptance thresholds are heterogeneous firms
  face on average - upwards sloping labor supply
  schedules
• However, with perfectly random matching the
  distribution of reservation wages a firm faces
  may not be very representative of the overall
  labor supply schedule
• May generate a lot of randomness at the firm
  level
• Needs many periods to converge to whatever the
  behavioral equilibrium is in this setting
• Solution
• Each firm gets matched with one worker from each
  third of the distribution of acceptance thresholds

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Standard Predictions

• Assumptions
• Firms and workers are rational and selfish
• Firms know that workers are selfish
• Implications
• Workers accept every positive wage offer
• Labor supply is horizontal at a wage of one
• Firms offer always the smallest acceptable wage
  to all their workers
• NO-Treatment w 1
• MW-Treatment w 220 (Minimum Wage)
• There is full employment in both treatments
• The minimum wage does not change employment but
  has strong distributive effects

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Predictions with fairness preferences

• Workers have heterogenous acceptance thresholds
• Firms face an upward sloping supply schedule
• Wages are much higher than predicted by the
  self-interest model
• Minimum wage may increase employment because more
  workers accept the wage offer
• Example 1
• Reservation wages of 0, 10, 100
• Marginal cost of hiring 3 instead of 2 workers
  are 3100 210 280 gt 260 ( MRP of 3rd
  worker)
• Third worker is not employed without the MW
• With the MW law the third worker will be employed
  because the marginal cost of the 3rd worker is
  220

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• Example 2
• Reservation wages of 30, 80, 130
• Marginal cost of hiring 3 instead of 2 workers
  are3130 280 230 lt 260
• Third worker is employed without the MW
• MW law has no employment effect

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The effect of MW on actual wages(increase and
spillover effect)
NO-MW sequence
Why do firms pay non-minimal wages in NO and more
than the minimum in MW?
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The effect of MW on reservation
wages(heterogeneity, fairness, increase)
NO_MW sequence
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Employment effectsWithout MW employment is
inefficiently low?
MW have the chance to raise employment
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• If reservation wages were constant across
  conditions average employment per firm should
  approximate 3 in the MW treatment
• However, the MW increases reservation wages

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Minimum wage leads to a small but significant
increase in employment
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Do firms chose profit maximizing wages?
Employment effect is the result of profit
maximizing firm behavior
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A temporary MW has permanent effects pre- and
post-MW economy exhibit different wages
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Distribution of wages in the pre- and the post-MW
economy
Why are wages in the post-MW economy so high?
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Why do employers not take more advantage of the
elimination of the MW?

• Related to the underutilization of subminimum
  wage opportunities in the field
• In Katz Krueger 92, 62 of restaurant managers
  believed that they could not attract qualified
  teenage workers at the subminimum wage
• Suggests that employers are labor supply
  constrained
• But why could they fill their ranks before the
  increase in the MW?

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Reservation wages in the pre- and the post-MW
economy
Post-MW median 200
Pre-MW median 150
Given these distributions, was it optimal to pay
higher wages in the post-MW economy?
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Distribution of profit maximizing wages in the No
condition across sequences
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Difference in reservation wages between pre and
post-MW economy is significant
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Removal of MW has no employment effect
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Summary

• Economists focus on how economic policy changes
  the incentives for private agents
• Economic policies have effects that go far beyond
  changing incentives
• Results suggest that minimum wages affect the
  perception of what constitutes a fair wage
• Minimum wage increases reservation wages
• Results suggest that minimum wage creates a kind
  of entitlement effect that is not fully
  reversible
• Explains asymmetric response of reservation wages

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• This effect on reservation wages gives rise to
  important wage employment effects
• Firms pay on average more than the minimum wage
  after the introduction of the MW
• Wages in the pre-MW economy are much lower than
  in a post-MW economy
• Employment rises less after the introduction
  compared to a situation with stable reservation
  wages
• Employment does not fall after the removal of the
  MW
• Our results lend support to the idea that the
  spillover effect and the under utilization of
  opportunities to pay subminimum wages in field
  data are driven by the impact of minimum wages on
  reservation wages