The interaction of minimum wage and severance payments in a frictional labor market: theory and estimation

We introduce a minimum wage and severance payments in an equilibrium labor market model with search frictions. We analyze how these policies affect endogenous job creation and destruction decisions and, more generally, the general equilibrium allocation. We structurally estimate the model's parameters and, with the resulting sets of estimates, we perform a quantitative welfare analysis. We conclude that when the dispersion in wages found in the sample is low and the share that workers receive from the surplus their job generates is below a particular level, the maximum level of welfare can be attained using either any of the two policies by themselves or an appropriate combination. However, as dispersion in wages increases, the minimum wage, by itself, can no longer reach the economy's maximum level of welfare; and when it is high enough, no policy in isolation can attain the economy's maximum level of welfare, a combination is required.