Turning A Blind Eye: Costly Enforcement, Credible Commitment And Minimum Wage

In many countries, the authorities turn a blind eye to minimum wage laws that they have themselves passed. But if they are not going to enforce a minimum wage, why have one? Or if a high minimum wage is not going to be enforced one hundred percent, why not have a lower one in the ¯rst place? Can economists make sense of such phenomena? This paper argues that we can, if a high o±cial minimum wage acts as a credible signal of commitment to stronger enforcement of minimum wage laws. We demonstrate this as an equilibrium phenomenon in a model of a monopsonistic labor market in which enforcement is costly, and the government cannot pre-commit to enforcement intensity. In this setting we also demonstrate the paradoxical result that a government whose objective function gives greater weight to e±ciency relative to distributional concerns may end up with an outcome that is less e±cient. The paper concludes by suggesting that the explanations o®ered in this paper may apply to a broad range of phenomena where regulations are imperfectly enforced.