An Analysis of the Impact of Minimum Wages on Firm Dynamics

The recent minimum wage increase may have a cleansing effect by raising labor costs and causing inefficient firms to exit, while it may encourage firm dynamics by stimulating the entry and growth of more productive firms due to the reduced competition caused by the exit of firms.

In addition to previous studies that have focused on manufacturing establishments and firms, this study analyzes the impact of minimum wage increases on industrial dynamics including entry and exit of firms and establishments and employment changes in a market economy that includes mainly non-manufacturing industries by utilizing data from Economic Census for Business Frame and Economic Census for Business Activity of the Ministry of Economy, Trade and Industry and the Ministry of Internal Affairs and Communications. The main findings from the analysis are as follows.

1. (1) Minimum wage increases are positively related to increases in labor productivity and TFP of firms, but this positive relationship is limited to firms and prefectures with higher productivity and wages.
2. (2) Japanese firms responded to minimum wage increases in 2011-2015 by reducing capital and regular employees and significantly increasing temporary employees. The total number of employees was not affected, but temporary employees replaced regular employees. The decrease in regular employees was more pronounced in firms with lower average wages and total factor productivity.
3. (3) Although this reduced the capital-labor ratio of firms, firms increased TFP supposedly by introducing IT technology such as e-commerce, with labor productivity increased.
4. (4) Raising the minimum wage is positively associated with encouraging firms to exit.

The impact of the minimum wage on firm dynamics is heterogeneous across firms. An increase in the minimum wage leads to an increase in productivity only for firms with high productivity and wage rates and are competitive.