DP1212 Minimum Wages: Curse or Blessing?

Author(s): Morten O Ravn, Jan Rose Sorensen
Publication Date: July 1995
Keyword(s): Human Capital Accumulation, Intergenerational Externality, Minimum Wages, Overlapping Generations
JEL(s): D90, E24, I29
Programme Areas: Human Resources
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=1212

In this paper we consider the effects of minimum wage legislation in an overlapping generations model. In our model there is an intergenerational externality in the accumulation of human capital since the production of human capital of every new generation depends positively on the average human capital stock of the preceding generation. This externality means that the competitive equilibrium allocation is sub-optimal, and every generation accumulates too little human capital. We show that in the case of identical agents, a minimum wage above the market wage can increase human capital accumulation and welfare. Furthermore, the first-best allocation can be attained through the implementation of a minimum wage. We introduce a cross-agent heterogeneity such that agents differ in their ability to produce human capital. In this case a (binding) minimum wage may produce unemployment, and it may increase or decrease human capital accumulation.