On the heterogeneous short‐term effects of minimum wages on labor demand

• Date: 01 June 2020
• Author: Juan A. Correa,Francisco Parro
• DOI: http://doi.org/10.1111/ijet.12236
• Published date: 01 June 2020

doi: 10.1111/ijet.12236

On the heterogeneous short‐term effects of minimum

wages on labor demand

Juan A. Correa*and Francisco Parro†

A strand of the literature documents no effects or even positive effects of a higher minimum

wage on employment. This evidence is frequently linked to the existence of monopsonistic

labor markets or search frictions. However, empirical studies show that these findings could

be related to a low short‐term minimum wage–employment elasticity in a competitive labor

market. We show that mixed theoretical employment effects of a minimum wage policy can be

predicted in the short term in assignment economies with price‐taker agents and no search

frictions.

Key words employment, labor demand, minimum wage

JEL classification J08, J23, J38

Accepted 21 December 2017

1 Introduction

The empirical literature documents a great variety of results on the employment effects of a

minimum wage policy. Research done up to the 1980s was primarily based on US time‐series data

and typically found negative employment impacts of minimum wages (see Brown, Gilroy, and

Kohen 1982, 1983 for surveys of this literature). However, beginning in the early 1990s, a new

wave of studies failed to detect a negative effect of higher minimum wages on employment, finding

instead either no effects or even positive effects (see, for example, Card 1992a, 1992b; Katz and

Krueger 1992; Card and Krueger 1994).

Theoretical models incorporating a monopsony power of firms have been successful in pre-

dicting non‐negative effects of a minimum wage policy on employment. These frameworks

consider either a purely monopsonistic labor market or search frictions that generate some

monopsony power for firms (see, for example, Flinn 2006).

1

On the other hand, Baker, Benjamin,

and Stanger (1999), and Meer and West (2016) show that no employment effects of minimum

wages might be simply associated with a low short‐term minimum wage–employment elasticity in

the context of competitive economies. Indeed, Baker, Benjamin, and Stanger (1999) find that

short‐term elasticity is not statistically different from zero, whereas long‐term elasticity is statis-

tically significant and about −0.3. The main implication of these studies is that the non‐negative

International Journal of Economic Theory 16 (2020) 184–195 © 2019 IAET184

*

Facultad de Economía y Negocios, Universidad Andres Bello, Santiago, Chile.

†

School of Business, Universidad Adolfo Ibáñez, Santiago, Chile. Email: francisco.parro@uai.cl

1

Manning (2003) provides a deep analysis of how the existence of frictions in the labor market gives employers potential

market power over their workers; thus, a monopsony arises not in the sense that there exists a single buyer of labor but

instead in the sense that the supply of labor to an individual firm is not infinitely elastic.