Minimum Wages, Unemployment and the Creation of Human Capital

This section expands the basic model presented in chapter four by stressing the importance of human capital. First, we assume that, instead of physical labor, human capital is used to produce output. This reflects the observation that economies with higher average skill levels are more productive than those with lesser skill levels. Second, drawing on the Lucas model (1988), we assume that the average level of human capital positively affects the production function of the individual firm. The intuition behind this idea is simple: it seems obvious that people who work among intelligent people are more productive than those who do not. However, Lucas assumed positive external effects in a dynamic model setting, an idea which can also be easily implemented in a static model, as will be shown in this chapter. Third, we assume that the household’s process to generate skills is positively influenced by the degree of unemployment. The rationale is that fear of unemployment influences the educational decisions of the households. This is based on the household’s belief that a higher level of education decreases the probability of losing a job.