This paper explores the effect of minimum wages on firms incentives to provide training for their employees. Our point of departure is a well-known paper by Acemoglu (1997), which argues that a more compressed structure of wages - such as is found in many European countries - gives firms more incentive to train. Acemoglu and Pischke (1999, 2003) view minimum wages as a source of wage compression and show that a rise in the minimum wage stimulates firm training. This result seems simple and compelling: When a minimum wage constraint is binding, a rise in training will increase the productivity of a firm’s workforce, but it will not lead to a rise in the wage. Thus training is more profitable under a minimum wage constraint than in the absence of this constraint, for in the latter case the rise in productivity will lead to a wage hike. It is on this account that minimum wages are conducive to training.
This paper considers another potentially important channel whereby minimum wages affect firm training: A rise in the minimum wage reduces the profitability of an employee, thereby making it more likely that the firm will fire the employee. In that case, however, the firm cannot appropriate the gains from training, and thus the firm will provide less of this training.
Whereas the Acemoglu model implies that minimum wages have a positive effect on training, empirical studies typically do not find significant positive or even negative results (e.g. Acemoglu and Pischke (2003), Grossberg and Sicilian (1999), Neumark and Wascher (1998) or Leighton and Mincer (1981)). Acemoglu and Pischke (2003) address this problem through a hybrid model in which an exogenously determined share of all workers are allowed to finance their training by accepting a lower starting wage. If this is prevented by a legal minimum wage, then the resulting fall in training is a second effect that counteracts the standard effect of wage compression.
This approach to the influence of minimum wages on training has several salient weaknesses - ones that our approach not share. First, the model of Acemoglu and Pischke (2003) is rather ad hoc: the distinction between the two groups of workers is arbitrary and it is not explained why some workers should be “credit-constrained” and others not. Secondly, the notion of financing training via wage cuts does not have clear empirical support (see for instance Loewenstein and Spletzer (1998)).
Furthermore, our model can explain phenomena that the model of Acemoglu and Pischke cannot. Specifically, our model provides a rationale for endogenous "spill-over effects," namely effects on the minimum wage on the training of workers who receive more than the minimum wage. There is empirical evidence for these effects, e.g. Lee (1999), DiNardo, Fortin and Lemieux (1996), Neumark, Schweitzer and Wascher (2004) and Acemoglu and Pischke (2003) find that the minimum wage affects not only the earnings of workers earning the minimum wage, but also the earnings of workers with higher wages. While our model can account for this phenomenon, that of Acemoglu and Pischke cannot.
Finally, ourmodel can explain another previously puzzling empirical regularity. Leighton and Mincer (1981) find that training is lower in states of the U.S. that have wage distributions that are relatively low, where the minimum wage is more likely to be binding.
The paper is organized as follows. In Section 2 we present a simple model of two effects - the "wage compression effect" (whereby minimum wages stimulate firm training) and the "firing effect" (whereby minimum wages raise separations and thereby reduce training) and derive the conditions under which one or the other dominates. This model generates a striking result. For "low-skilled" workers (to be precisely defined below), a rise in the minimum wage reduces firm training. In short, minimum wages create a "low-skill trap," workers who start out as low-skilled fail to raise their productivity since firms lack the incentive to train them. For workers with higher skills, however, the opposite holds: A rise in the minimum wages leads firms to provide more training to them.
By implication, minimum wages generate inequality in workers’ training. The higher the minimum wage, the less training will the low-skilled workers receive and the more the high-skilled workers get. This potentially important implication of minimum wages has not received attention in the labor economics literature thus far. The relevant empirical considerations are covered in Section 3. Section 4 concludes.
