Minimum Wages: Curse or Blessing

Abstract

In this paper we consider a new channel through which a minimum wage legislation can affect the economy. We look at an overlapping generations economy in which skills are endogenously determined. Skills, or human capital, is determined by the average skill level of the previous generation and by the amount of effort that agents put into schooling. Because of the intergenerational externality, the competitive equilibrium is sub-optimal and is characterized by agents undertaking too little schooling. We show that when all agents are identical, a minimum wage legislation can attain the first-best solution, and this may be thought of as an elimination of low-productivity jobs. This is not possible when agents differ. We model cross-agent heterogeneities through the effectiveness with which agents can accumulate human capital through schooling. In this case we show that a binding minimum wage may produce unemployment and may increase or decrease the aggregate human capital level.

JEL Classification: D90, E24, I29