Fairness Perceptions and Reservation Wages - the behavioural effects of minimum wages Discussion Alfonso Arpaia DG ECFIN European Commission Brussels, 25 November 2009

Minimum Wages Source: Tito Boeri and Jan van Ours (2008), The Economics of Imperfect Labor Markets, Princeton University Press.

Motivation behind minimum wages Equity –Fairness and protection of workers in relatively weak positions –Reducing in-work poverty (together with other policy instruments) –Preventing social dumping (setting specific minimum pay rules ) Efficiency –Remedy to market failures (monopsonistic competition, information asymmetries) –Increasing incentives to work (by targeting labour supply) –Increasing workers productivity (higher investment in training, improved social inclusion, higher employees morale)

What are We Talking About? MW sets a wage floor. It pushes the wage distribution from below –affects those at the lower end of the wage distribution It affects wages further up in the wage distribution –Spillover effects (i.e. increase in the elasticity of labour supply)

EU practice - countries with the statutory minimum wage Kaitz index: minimum monthly wage as a % of average monthly earnings in industry and services (%) France, Greece and Estonia: minimum wages refer to 2007 and minimum wages adjusted for PPP to France, Greece: the Kaitz index is taken from the OECD (not directly comparable data)

A Competitive Labor Market w w L0L0 L LsLs L1L1 w*w* LdLd u L2L2

w wmwm LmLm L LsLs L*L* w*w* LdLd mhc w wmwm LmLm L*L* w*w* LsLs LdLd L w L (w) Pure monopsonist w A A

When MW increases employment Monopsonistic competition (Manning, 2003): many employers, but fewer vacancies to apply for –Eg hiring and firing cost implies less dynamism and some market power on the side of employers Search frictions and mobility costs in the labour market –Search intensity Efficiency wages: –when imperfect monitoring of the productivity of workers, wage as a disciplining device –Firms pay higher wages but elicit higher effort as the cost of layoffs is larger Theory

When it increases productivity Supply side: as the productivity of a job depends on the investment in human capital (Cahuc and Michel 1996; Acemoglu and Pischke 1999). A minimum wage induces workers to acquire education in order not to be crowded out. Similar effect may arise on the demand side (Acemoglu 2001) because the minimum wage increases the number of vacancies for high-productivity jobs issued by employers. Theory

Set up of the paper Similar to monopsony –6 identical firms and 18 workers; –Each firm is matched with 3 workers in each period (small firms) –Employers maximize profits –Workers have different acceptance thresholds (i.e RW) –If wage offer > than RW contract signed –Otherwise contract rejected and zero earnings (no outside option) –Structure of ultimatum game is imposed those rejecting prefer to get nothing to some positive small payoff (why? role of culture/institutions? ) –The distribution of RW reflects differences in the vertical fairness motive (How UB impact RW or what about a likelihood of a shock that breaks the match)

Similar to monopsony –Upward sloping labour supply due to different RW –Firms anticipate that some workers will reject wage offer if too low and have incentive to increase wages (mobility costs; what if UB finance mobility?) –Firms increase employment if they pay higher wages - i.e. equal or above the MW

Findings –Fairness influences RW and shape labour supply –An increase in MW rises RW and push employers to pay wages higher than the MW –Employment effects potentially uncertain but positive in the experiment –the adjustment of RW to the MW is asymmetrical the employment effects of the MW are smaller in the removal sequence than in the introduction sequence –Thus the introduction of the MW truncates the distribution of permissible wages cutting all (subminimum) wages below the MW. This change in the set of feasible wages influence perception of fairness –The asymmetry is due to entitlement effects created by the effect of the introduction of MW on RW

w L L LsLs L*L* w*w* LdLd w wmwm LmLm L*L* w*w* LsLs LdLd L w L w A A A1A1 A2A2 Small increase in RW Big increase in RW LmLm

What is the impact of UB on RW when UB are introduced as an outside option (in the NO MW treatment)? Would workers' fairness concerns require higher RW after the imposition of the MW when UB are presents? Is the increase in RW higher the closer the wage floors generated by the MW and the UB? Spillover from the MW workers to high-skilled workers (as the RW of highly skilled may depend on the actual wages of unskilled workers who earn more after an increase in minimum wages) Also how much an increase in wages of high-skilled workers (e.g. SBTC) pulls up RW of minimum wage workers who try to maintain their relative wages More general what happens if fairness is defined in terms of wages in alternative market transactions? –E.g if wages of unskilled fall should the RW and the MW follow this decline