Low-Wage Labor Markets and the Power of Suggestion

This paper suggests that a non-binding minimum wage may act as a focal point for tacit collusion in the low-wage markets, pulling down wages of some otherwise higher paid workers. A simple game-theoretic argument explaining the emergence of collusive equilibrium is developed, which is then tested by examining minimum wage observations. The paper uses 1990-2002 CPS data on service occupation workers to estimate p-Tobit and double-hurdle models. Results suggest that on average 19.3% and as much as 31% of service occupation workers who earned minimum wage or less could be affected by collusive wage-setting during this time period. The collusive behavior of low-wage employers resulting in emergence of a monopsony-like equilibrium can potentially explain a number of controversial empirical effects associated with the minimum wage, including little to no effect on employment