December 2002

IZA DP No. 662: Getting It Right: Employment Subsidy or Minimum Wage?

revised version published as "Dealing with Monopsony Power: the Case for Employment Subsidies" in: Economics Letters, 2007, 94 (1), 83-89

In monopsony models of the labour market either a minimum wage or an employment subsidy financed by a lump sum tax on profits can achieve the efficient level of employment and output. Incorporating working conditions into a monopsony model where higher wages raise firm labour supply, but less attractive working conditions reduce it, changes these policy implications. Specifically, a minimum wage policy could, in contrast to an employment subsidy, cause working conditions to deteriorate and welfare to fall. Empirical evidence from the Republic of Trinidad and Tobago shows that a minimum wage may indeed cause working conditions to worsen.