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Turning a Blind Eye: Costly Enforcement, Credible Commitment and Minimum Wage Laws

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Author Info
Arnab K. Basu () (College of William and Mary)
Nancy H. Chau () (Cornell University and IZA)
Ravi Kanbur () (Cornell University)

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Abstract

In many countries, non-compliance with minimum wage legislation is widespread, and authorities may be seen as having turned a blind eye to a legislation that they have themselves passed. But if enforcement is imperfect, how effective can a minimum wage be? And if non-compliance is widespread, why not revise the minimum wage? This paper examines a minimum wage policy in a model with imperfect competition, imperfect enforcement and imperfect commitment, and argues that it is the combination of all three that produces results which are consistent with a wide range of stylized facts that would otherwise be difficult to explain within a single framework. We demonstrate that turning a blind eye can indeed be an equilibrium phenomenon with rational expectations subject to an ex post credibility constraint. Since credible enforcement requires in effect a credible promise to execute ex post a costly transfer of income from employers to workers, a government with an objective function giving full weight to efficiency but none to distribution is shown, paradoxically, to be unable to credibly elicit efficiency improvements via a minimum wage reform.

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Paper provided by Institute for the Study of Labor (IZA) in its series IZA Discussion Papers with number 2998.

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Length: 37 pages
Date of creation: Aug 2007
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Handle: RePEc:iza:izadps:dp2998

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Related research
Keywords: non-compliance; minimum wage; dynamic consistency; equity and efficiency;

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Find related papers by JEL classification:
D6 - Microeconomics - - Welfare Economics
E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination
J38 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Public Policy

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    Other versions:
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    Other versions:
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  11. Fershtman, Chaim & Fishman, Arthur, 1994. "The 'perverse' effects of wage and price controls in search markets," European Economic Review, Elsevier, vol. 38(5), pages 1099-1112, May. [Downloadable!] (restricted)
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  16. Portugal, Pedro & Cardoso, Ana Rute, 2002. "Disentangling the Minimum Wage Puzzle: An Analysis of Worker Accessions and Separations," IZA Discussion Papers 544, Institute for the Study of Labor (IZA). [Downloadable!]
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  17. Kydland, Finn E & Prescott, Edward C, 1977. "Rules Rather Than Discretion: The Inconsistency of Optimal Plans," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 473-91, June. [Downloadable!] (restricted)
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  21. Basu, Arnab K & Chau, Nancy H & Kanbur, Ravi, 2006. "A Theory of Employment Guarantees: Contestability, Credibility and Distributional Concerns," CEPR Discussion Papers 5784, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
    Other versions:
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