Do minimum wages deliver what they promise? Effects of minimum wage on employment, output, and income inequality from occupational choice theory

By Luis Medrano-Adán & Vicente Salas-Fumás. Excerpts:

Vicente Salas-Fumás
University of Zaragoza

Luis Medrano-Adán
View the author's ORCID record
CUD (Zaragoza), Academia General Militar, Spain

"Abstract

This paper addresses the unresolved debate on the effects of minimum wages on output, employment, and income inequality by modeling an occupational choice economy calibrated for a representative OECD economy. The minimum wage sets a minimum skill requirement for employees, which reduces the effective labor supply and raises its price. Consequently, salaries increase, business profits fall, and some entrepreneurs transition to solo self-employment. With a minimum-to-average wage ratio of 0.43 (the OECD countries average in 2020), a 10% increase in the minimum wage reduces output, employment, and inequality among employees by 0.2%, 1.0%, and 2.1%, respectively, and increases total income inequality by 0.57%. If the minimum-to-average wage ratio were 0.55, output, employment, and inequality among employees would decrease by 0.87%, 3.55%, and 5.19%, respectively, and income inequality would rise by 2.09%. In summary, the effects are mainly negative, contrary to what is promised, and quantitatively large for high minimum-to-average wage ratios."

"This paper models an occupational choice economy (Lucas, 1978, Rosen, 1982) and compares the equilibrium outcomes in terms of income inequality, output and occupational group sizes, with and without a minimum wage and/or changes in the existing minimum wage. The parameters of the model are calibrated using data representative of Organization for Economic Co-operation and Development (OECD) countries. The economy includes four possible occupational groups: employees, voluntary and involuntary solo self-employed, and entrepreneur-managers (employers). Each group contributes to production in a different way and receives an income according to this contribution. Individuals endowed with general skills choose the occupation that maximizes their income given their skills. In the market equilibrium, no individual wants to change occupation, and the entrepreneur-managers’ demand for operational skills is equal to the total supply of those who choose to work as employees. We calculate the equilibrium outcomes, including the total output, the contribution of each occupational group and the distribution of labor income for all individuals and within each occupational group. Comparative static analysis allows us to evaluate the changes in equilibrium outcomes due to changes in the exogenous parameters, including the initial value of the ratio of the minimum wage to the median wage, the so-called Kaitz index (KI), and compare them with the effects of changes in the minimum wage evaluated in empirical studies."