Wage Distribution and Economic Growth

15/12/2005 |  Friedman Amit
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Welfare Policy and Labor Market
Wage Distribution and Economic Growth
Amit Friedman
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 non-monotonic 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.
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