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

  • Basu, Arnab K.


    (Cornell University)

  • Chau, Nancy


    (Cornell University)

  • Kanbur, Ravi


    (Cornell University)

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
Date of revision:
Publication status: published in: Economic Journal, 2010, 120 (543), 244 - 269
Handle: RePEc:iza:izadps:dp2998
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