Minimum Wages, Efficiency and Welfare

Abstract

It has long been argued that a minimum wage could alleviate efficiency losses from monopsony power. In a general equilibrium framework that quantitatively replicates results from recent empirical studies, we find higher minimum wages can improve welfare, but most welfare gains stem from redistribution rather than efficiency. Our model features oligopsonistic labor markets with heterogeneous workers and firms and yields analytical expressions that characterize the mechanisms by which minimum wages can improve efficiency, and how these deteriorate at higher minimum wages. We provide a method to separate welfare gains into two channels: efficiency and redistribution. Under both channels and Utilitarian social welfare weights the optimal minimum wage is $15, but alternative weights can rationalize anything from $0 to $31. Under only the efficiency channel, the optimal minimum wage is narrowly around $8, robust to social welfare weights, and generates small welfare gains that recover only 2 percent of the efficiency losses from monopsony power.

Minimum Wages and Optimal Redistribution in the Presence of Taxes and Transfers

“…This is one of the forces that can attenuate the direct employment effects discussed above: part of the jobs that are destroyed by the minimum wage effects on low productivity firms are absorbed by more productive firms. This mechanism is similar, albeit simplified, to the reallocation argument developed in Berger et al (2022). 9…”

“…14 This approximation accommodates the results of Berger et al (2022) which find that efficiency increases are unlikely to play a large role in the welfare implications of increasing the minimum wage. Banfi and Villena-Roldan, 2019;He et al, 2021).…”

“…Third, this paper adds to a literature that studies the interaction of different policies in second-best contexts (e.g., Diamond and Mirrlees, 1971;Atkinson and Stiglitz, 1976;Gaubert et al, 2020;Ferey, 2020). Fourth, the model presented adds to the literature that studies the theoretical foundations of monopsony power and firm wage premiums (e.g., Card et al, 2018;Haanwinckel, 2020;Berger et al, 2021Berger et al, , 2022Engbom and Moser, 2021;Huneeus et al, 2021;Jarosch et al, 2021;Kroft et al, 2021;Lamadon et al, 2022). Finally, the empirical results add to a large empirical literature, referenced throughout the paper, that studies the effects of minimum wages on labor market and firms outcomes.…”

“…Relative to the related literature, one novel aspect of Proposition I is that it explicitly incorporates profits to the welfare discussion. While Berger et al (2022) recognizes the potential of the minimum wage for affecting both the labor income distribution and the labor share, previous analyses based on optimal policy frameworks usually abstract from profits and only consider tradeoffs between workers (Hungerbühler and Lehmann, 2009;Lee and Saez, 2012;Cahuc and Laroque, 2014;Lavecchia, 2020). Giving a role to profits, which potentially decrease after minimum wage increases, makes the minimum wage potentially valuable for redistributing from capitalists to workers on top of its effects on the labor income distribution.…”

“…The papers mentioned above follow the optimal tax tradition. Alternative approaches to analyze the welfare impacts of the minimum wage include the structural work of Flinn (2006), Wu (2021), and Berger et al (2022), which mostly focus on efficiency and misallocation and abstract from the tax system, and Dworczak et al (2020), that analyze redistribution through markets using mechanism design techniques. Finally, Hurst et al (2021) develop a general equilibrium model to compare the minimum wage policy to tax-based redistribution, concluding that the latter dominates the former.…”