Can Minimum Wages Raise Workers’ Incomes in the Long Run?

• Date: 01 December 2016
• Published date: 01 December 2016
• Author: THOMAS MOUTOS,GEORGE ECONOMIDES
• DOI: http://doi.org/10.1111/jpet.12216

CAN MINIMUM WAGES RAISE WORKERS’INCOMES

IN THE LONG RUN?

GEORGE ECONOMIDES

Athens University of Economics and Business and CESifo

THOMAS MOUTOS

Athens University of Economics and Business and CESifo

Abstract

Using an intertemporal model of saving and capital accumulation with

two types of agents we demonstrate that it is impossible for any bind-

ing minimum wage to increase the after-tax incomes of workers if the

production function is Cobb–Douglas with constant returns to scale,

or if there are no differences in ability among workers. Moreover, it

is impossible to increase the incomes of employed workers through

minimum wage legislation, even under decreasing returns to scale and

heterogeneity of ability among workers, unless the support provided to

unemployed workers is far below what they would earn in the absence

of minimum wages.

1. Introduction

The use of minimum wages (MWs) as a way to reduce poverty and redistribute income

has re-emerged forcefully in recent policy discussions. Critics of minimum-wage legisla-

tion focus usually on its disemployment effects1and on whether it is an effective redis-

tributive tool.2While these issues are subject to intense discussion among economists,

1The early consensus regarding the effects of minimum wage increases on employment in the United

States (e.g., Brown, Gilroy, and Kohen 1982) indicated some disemployment effects, mainly concen-

trated on teenagers and young adults. Following Card and Krueger’s (1994) study questioning the

existence of disemployment effects, there have been many studies but no consensus regarding their

size or existence (see, e.g., Manning 2003; Neumark and Wascher 2008; Dube, Lester,and Reich 2010;

Meer and West 2013).

2The issue of whether the minimum wage is an efficient redistributive tool is not the subject of

this paper; for papers discussing this issue, see, for example, Allen (1987), Guesnerie and Roberts

George Economides, Athens University of Economics and Business, School of Economic Sciences, De-

partment of International and European Economic Studies, 76 Patission Street, Athens 10434, Greece

(gecon@aueb.gr). Thomas Moutos, Athens University of Economics and Business, School of Economic

Sciences, Department of International and European Economic Studies, 76 Patission Street, Athens

10434, Greece (tmoutos@aueb.gr).

We thank Stelios Arvanitis, Sarantis Kalyvitis, Theodore Palivos, and Apostolis Philippopoulos for

helpful comments and discussions. The comments and suggestions of the Editor and an anonymous

referee have improved both the scope and the substance of the paper.

Received May 26, 2016; Accepted June 21, 2016.

C2016 Wiley Periodicals, Inc.

Journal of Public Economic Theory, 18 (6), 2016, pp. 961–978.

961

962 Journal of Public Economic Theory

it is taken for granted by both sides of this debate that, following a MW increase, the

incomes of (at least some) workers that remain in employment will be higher (e.g., Card

and Krueger 1995; Saint-Paul 2000; Manning 2003; Neumark and Wascher 2008).3

The objective of the present paper is to argue that this presumption is by no means

guaranteed once we move away from static models and allow for capital accumulation.4

To this purpose in Section 2 we construct a model with two types of agents, that is, work-

ers and capitalists (e.g., Judd 1985; Acemoglu 2009). The latter are a homogeneous

group, do all the saving and own the capital stock, whereas the workers are differenti-

ated according to their ability. Assuming a constant-returns-to-scale Cobb–Douglas pro-

duction function, we demonstrate in Section 3 that the imposition of any binding MW,

in addition to generating unemployment amongst the least able workers, will also re-

duce both the steady-state capital stock and the after-tax incomes of employed workers.

Our result also implies that the (joint) existence of economic profits and differences

in ability among workers can allow workers above an ability threshold to increase their

(after-tax) incomes through the imposition of a binding MW; however, they can achieve

this only at the expense of low-ability workers who become unemployed. The effects of

minimum-wage legislation can thus match with what Stigler (1970) termed Director’s

Law—according to which public interventions are made for the primary benefit of the

middle classes, and financed with taxes which are borne in considerable part by the

(rich) capitalists and the poor.

In Section 4, we extend the model by allowing for endogenous labor supply and,

as a result, heterogeneity in the amount of labor offered by workers of different ability.

These changes do not alter the main findings of Section 3, and they bring into focus

the role of welfare support for the unemployed. The presence of two distinct groups of

agents in our framework—with workers not saving and capitalists not working—raises

the question of whether a Ramsey-type framework with worker heterogeneity but not

with two “classes” of agents (workers versus capitalists) would be a more appropriate way

to analyze the consequences of MWs.5We develop such a model in Section 5. The results

we derive are similar to the ones we derive in the model with the two distinct groups of

agents. In particular, we demonstrate analytically two things. First, it is impossible for

the imposition of MWs to increase employed workers’ total incomes when there are

constant returns to scale. Second, in the case of diminishing returns to scale, the only

possibility for the imposition of MWs to increase employed workers’ total incomes arises

when the increase in (after-tax) wage income is such that it outweighs the losses they

suffer from their other sources of income (capital income and dividends). However,

after extensive experimentation with a wide range of plausible parameter values we have

not been able to find a single case in which the total income of employed workers

increases even when no welfare support is provided to the unemployed. One way to

understand this finding is by noting that workers can no longer extract a larger share

of output without hurting themselves. This is because a rise in the wage rate earned by

workers reduces the profits of the firms and the dividends received by the workers who

(1987), Marceau and Boadway (1994), Freeman (1996), Boadway and Cuff (2001), Burkhauser and

Sabia (2007), Lee and Saez (2012), and Cahuc and Laroque (2014).

3This effect is behind some political economy explanations regarding the unwillingness of policymak-

ers to dismantle unemployment-generating labor-market legislation (e.g., Saint-Paul 2000; Adam and

Moutos 2011).

4The effects of minimum wages on capital accumulation has not been much studied in the empirical

literature (for a notable exception see Sorkin 2015).

5We wish to thank an anonymous referee for bringing this possibility to our attention.