he conventional wisdom that imposition of a minimum wage reduces employment has recently been powerfully challenged. In Myth and Measurement, Card and Krueger have shown that the overall empirical effect of a minimum wage on employment is small or negligible and, sometimes, even positive. In Discussion Paper No 1524, Gianni De Fraja offers a theoretical model of the labour market that accounts for these findings. In conventional models, because workers are paid the value of their marginal product, the introduction of a minimum wage rate leads to the dismissal of workers whose productivity falls below the wage. De Fraja suggests instead that employment contracts are multidimensional, in the sense that employers can vary not only wages but also working conditions – for example, by making jobs more tiring or more difficult, or by asking employees to work longer hours. While the firm’s profit is reduced as a consequence of the minimum wage, it can limit the extent of the reduction by retaining workers whose productivity is currently below the wage rate and increasing their productivity by altering the other dimensions of their employment.

The model can be extended to consider the cases where employers invest in fixed capital and in training. De Fraja shows that, in both cases, some firms increase their employment in response to an increase in the level of the minimum wage. The paper concludes that minimum wage legislation will stimulate investment and encourage the training of low-paid workers – both positive effects which, it can be argued, justify the associated losses in firms’ profits.

Minimum Wage Legisation, Work Conditions and Employment
Gianni De Fraja