Synergies in labour market institutions: The nonlinear effect of minimum wages on youth employment

Empirical evidence on the effect of minimum wages on youth employment is inconclusive, with studies pointing to negative, positive or insignificant effects. In trying to explain some of the conflicting evidence, this paper employs a fixed-effects model to test for synergies between minimum wages and other labour market institutions. Using an unbalanced panel dataset of 19 OECD countries over 1985-2013, it is found that the effect of minimum wages on youth employment varies with institutional variables. In particular, institutions that enforce labour market rigidity, such as unemployment benefits and union density, exacerbate the negative effect of minimum wages on youth employment. Conversely, high government expenditure on active labour market policies, which mainly comprise the provision of training to the unemployed, dampens the effect. The presence of significant synergies indicates that many panel data models are misspecified, as they omit the interactive term between minimum wages and other labour market institutions. This failure to model nonlinearities might account at least for some of the conflicting evidence with regards to the effect of minimum wages on employment. Moreover, a cross-country analysis shows that minimum wage effects are most severe in rigid labour markets with generous unemployment benefit schemes and high union density. In contrast, flexible labour markets are estimated to exhibit negligibly small minimum wage effects, even under low government expenditure on active labour market policies. These findings imply that policymakers should consider the full spectrum of institutions they face in order to adequately assess the potential economic costs of adjusting minimum wages.