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Wage Distribution and Economic Growth

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  • Amit Friedman

    () (Bank of Israel)

Abstract

This paper presents the following question: what is the long-run effect of the minimum wage on economic growth? In order to deal with this question, a model that creates a synthesis between labor search theory and endogenous growth theory is constructed. In the model, the wage distribution, investment in human capital, active production technologies and long-run growth are all determined endogenously. The analysis implies that policies that affect directly the wage distribution such as minimum wage laws, have a nonmonotonic effect on economic growth. The positive effect is due to the change in production technologies that creates an incentive to increase investment in human capital. The negative effect is the result of a disproportional reduction of monopsonistic power of firms. This affects negatively the skill premium, causing a reduction in investment in human capital. This negative effect of the minimum wage is the novel result of integrating labor market frictions in an endogenous growth framework. The aggregate effect on growth depends on the structural parameters of the model. The model is flexible enough to analyze also other policies that affect the reservation wage - such as unemployment benefits and negative income taxation.

Suggested Citation

  • Amit Friedman, 2005. "Wage Distribution and Economic Growth," Bank of Israel Working Papers 2005.13, Bank of Israel.
  • Handle: RePEc:boi:wpaper:2005.13
    as

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    References listed on IDEAS

    as
    1. Romer, Paul M, 1986. "Increasing Returns and Long-run Growth," Journal of Political Economy, University of Chicago Press, vol. 94(5), pages 1002-1037, October.
    2. Christopher A. Pissarides, 2000. "Equilibrium Unemployment Theory, 2nd Edition," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262161877, March.
    3. Cahuc, Pierre & Michel, Philippe, 1996. "Minimum wage unemployment and growth," European Economic Review, Elsevier, vol. 40(7), pages 1463-1482, August.
    4. Zvi Eckstein & Kenneth I. Wolpin, 1995. "Duration to First Job and the Return to Schooling: Estimates from a Search-Matching Model," Review of Economic Studies, Oxford University Press, vol. 62(2), pages 263-286.
    5. Audra J. Bowlus & Zvi Eckstein, 2002. "Discrimination and Skill Differences in an Equilibrium Search Model," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 43(4), pages 1309-1345, November.
    6. Fabien Postel-Vinay & Jean-Marc Robin, 2002. "Equilibrium Wage Dispersion with Worker and Employer Heterogeneity," Econometrica, Econometric Society, vol. 70(6), pages 2295-2350, November.
    7. Albrecht, James W & Axell, Bo, 1984. "An Equilibrium Model of Search Unemployment," Journal of Political Economy, University of Chicago Press, vol. 92(5), pages 824-840, October.
    8. David Neumark & Olena Nizalova, 2007. "Minimum Wage Effects in the Longer Run," Journal of Human Resources, University of Wisconsin Press, vol. 42(2).
    9. Askenazy, Philippe, 2003. "Minimum wage, exports and growth," European Economic Review, Elsevier, vol. 47(1), pages 147-164, February.
    10. Flug, Karnit & Galor, Oded, 1986. "Minimum Wage in a General Equilibrium Model of International Trade and Human Capital," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 27(1), pages 149-164, February.
    11. Jonathan Temple, 1999. "The New Growth Evidence," Journal of Economic Literature, American Economic Association, vol. 37(1), pages 112-156, March.
    12. Philippe Aghion, 2002. "Schumpeterian Growth Theory and the Dynamics of Income Inequality," Econometrica, Econometric Society, vol. 70(3), pages 855-882, May.
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