Economic growth and welfare in a OLG model with regulated wages and consumption taxes

Abstract

Since little attention, despite a long lasting debate, has been paid to the effects of the regulation of wages on economic growth and welfare, this paper investigates such effects within a textbook OLG framework with an unemployment insurance scheme financed by the government at balanced budget with a consumption tax on the younger generation. Some new results, so far escaped closer scrutiny by the economic growth literature and which may have interesting policy implications, emerge: i)introducing minimum wages may have a favourable impact on the long run output levels despite the unemployment occurrence; ii) under suitable conditions a regulated-wage economy performs always better than a competitive economy; iii) despite the fact that the tax rate tends to reduce the consumption of the young, the long run lifetime welfare may be higher than in the market wage frame; iv) a welfare-maximising value of the minimum wage (and thus of the proportional consumption tax rare) is picked up. Our paper offers interesting insights in terms of comparing two different forms of capitalist economies in the long-run: the standard market-clearing wage economy vs. the regulated-wage frame where the government distorts individuals' decisions setting wages according to a national low. Thus, the employees' working income increases and unemployment occurs. We show that introducing minimum wages - together with an unemployment insurance mechanism financed at balanced budget - may increase the long-run income and the lifetime welfare as compared with the competitive economy.