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Welfare Reform on the Web (July 2008): Minimum Wage - Overseas

Holdup in oligopsonistic labour markets: a new role for the minimum wage

L. Kaas and P. Madden

Labour Economics, vol.15, 2008, p. 334-349

The holdup problem of the labour market says that firms invest too little since workers can capture some of the return on investment after the costs of investment are sunk. When a firm invests more, it may voluntarily want to pay higher wages in order to attract workers from its competitors. Consequently, part of the returns on higher investment accrue to workers and not to the firms who bear all the investment costs. As a result, investment in inefficiently low. The holdup problem can be removed by the imposition of a binding minimum wage which alleviates the adverse effects of oligopsonistic wage competition. Whenever the minimum wage binds, firms optimally wish to pay a lower wage. By investing slightly more, a firm is not inclined to raise wages but keeps paying the minimum. Hence, additional investment does not translate into higher wages, so that all the gains accrue to the firm.

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