Minimum Wage Increases and Firm Adjustment: Productivity, employment structure, and capital responses

This paper re-examines the effects of minimum wage increases on firm productivity and business dynamism in Japan using microdata from the Economic Census (2012, 2016, and 2021).

Using the Foster–Haltiwanger–Krizan (2001) decomposition, we first document a sharp slowdown in both labor productivity and total factor productivity (TFP) growth after 2015. The decline is mainly driven by a substantial weakening of within-firm productivity improvements, while reallocation effects—captured by covariance terms reflecting the expansion of more productive firms—remain consistently positive and sizable throughout the period. This suggests that competitive reallocation mechanisms continued to operate even as aggregate productivity growth weakened.

At the prefectural level, minimum wage growth is generally positively correlated with labor productivity and TFP growth. However, the underlying mechanisms differ markedly across periods. During the moderate increase phase (2011–2015), minimum wage growth is associated with more substantial entry effects and weaker exit effects, whereas during the rapid increase phase combined with the COVID-19 shock (2015–2020), entry effects weaken and exit effects become more pronounced, indicating a nonlinear relationship between minimum wage policy and business dynamism.

Firm-level panel regressions show limited evidence for a statistically significant and robust productivity-enhancing effect of minimum wage increases. Instead, firms primarily adjust through changes in input composition, including shifts in employment types, reductions in temporary employment, and capital adjustments–labor ratios. Instrumental variable estimations exploiting economically connected commuting areas across prefectural borders to address endogeneity concerns yield similar conclusions, with small and unstable direct effects on productivity.

Overall, the findings suggest that minimum wage increases in Japan mainly induce firms to adapt through organizational and input reallocation rather than through immediate improvements in technical efficiency. The impact of minimum wage policy critically depends on the pace of increases and macroeconomic conditions, underscoring the importance of complementary productivity-enhancing policies if minimum wage hikes are to contribute to sustained productivity growth.