The argument that minimum wage hikes bring productivity growth is attracting attention in Japan (Atkinson, 2019a). As increasing productivity is one of the top priority challenges facing the Japanese economy, the idea of raising the minimum wage in order to spur productivity growth has piqued interest among policymakers. Does a minimum wage hike really lead to productivity growth? I hope to contribute to the policy debate on productivity growth by clarifying Atkinson's argument (2019a), presenting a policy design approach and reviewing the points of the argument from the viewpoint of economic theory.
Policy Update 078
Will A Minimum Wage Hike Bring Productivity Growth?
Review of the Argument that a Minimum Wage Hike Brings Productivity Growth
Atkinson (2019a) argues that minimum wage hikes bring productivity growth referring a recent finding from UK (Rizov et al., 2016), which is attracting policy makers' attention in Japan. Atkinson maintains that it is especially important to increase productivity considering the current shrinkage of the population that Japan is faced with, and I agree with this view. The challenge is determining what kind of policy is the most effective for launching productivity growth in Japan.
Looking closely into his argument, you see that Atkinson stresses the quality of management teams as a factor behind the lack of productivity growth in Japan. At the root of Atkinson's argument is the question of how management teams can be made to take action through policy initiatives, since the cycle of productivity growth leading to wage growth is malfunctioning. Atkinson emphasizes a reverse direction of this circular causality and arrived at the conclusion that minimum wage should be raised in order to compel management teams to carry out the reforms that are necessary for increasing productivity (Note 1).
Policy Design and Incentives
By considering an incentive-based policy design approach, we can clarify the main points of Atkinson's argument. If we are to design a policy for the purpose of achieving wage growth, one option is to create a program through which preferential treatment is granted to firms that raise wages. In this case, the government sets a certain condition and rewards firms if they take action that satisfies the condition. Indeed, this policy approach has been adopted in Japan in order to promote wage growth (Note 2). The problem with this approach is that the status quo does not change at all unless firms take action in response to the policy.
As another approach, the government requests that firms raise wages. The "request" does not provide significant incentive to firms, nor is it legally binding, so it is presumed to have only a limited effect on wage growth. Ultimately, Atkinson's argument appears to be that if the management team is left to act at their own discretion, nothing changes, diminishing prospects for growth.
A minimum wage hike represents an idea of imposing a penalty, in particular, for firms that only pay low wages to employees. This policy approach is designed to give less productive firms an incentive to increase productivity to be able to make the additional wage payments. Naturally, raising the minimum wage is also expected to have strong side effects, so it is desirable for policymakers to carefully analyze the situation while making use of expert knowledge in relevant fields.
Distinguishing between the Concepts of Productivity at the Micro and Macro Levels
Due to the fact that Atkinson's argument for increasing productivity by raising the minimum wage is an incentive-based policy design, it is necessary to first review the potential mechanisms which may explain how a minimum wage hike can actually achieve the effect of increasing productivity. Here, let me provide explanations that will allow you to come to an intuitive understanding of the potential effects of the approach from the perspective of economic theory.
First, we need to distinguish between the concepts of productivity at the micro and macro levels. Productivity at the micro level means at the level of individual firms. On the other hand, productivity at the macro level means that of the overall Japanese economy (e.g., average productivity). Therefore, when discussing the impact of a minimum wage hike on productivity, we must consider whether productivity grows at the level of individual firms or at the level of the overall Japanese economy, or at both levels.
According to Atkinson's argument (2019a), a minimum wage hike could have an impact on productivity at both the micro and macro levels. While the argument that a minimum wage hike promotes reforms that enable productivity growth refers to the impact on individual firms' productivity, the exit from the market of less productive firms that cannot meet the minimum wage threshold also affects the productivity of the overall Japanese economy.
Below, I provide an understanding of the effects of a minimum wage hike while reviewing both micro- and macro-level productivity as well as the relationship between the two.
Individual Companies' Productivity Growth Corresponds to a Rightward Shift of the Productivity Distribution
Individual firms' productivity growth is considered to correspond to a rightward shift of the productivity distribution. Figure 1 shows an image of the productivity distribution shifting to the right after a minimum wage hike under the hypothesis that a minimum wage hike leads to productivity growth (Hypothesis 1)
If productivity increases in individual firms, the productivity of the overall Japanese economy also rises. In other words, productivity grows at both the micro and macro levels. Therefore, if it is empirically shown that a minimum wage hike causes a rightward shift, it could be evidence supporting policy implementation (Note 3).
In empirical analysis, the use of firm-level micro data is particularly important. It should be mentioned that if macro-level data tabulated by region are used, it becomes difficult to distinguish between correlation and a causation. If you create a scatter diagram for the relationship between minimum wage and productivity by region, a positive correlation is indeed observed. However, whether there is a causal relationship should be carefully verified. One potential factor behind the presence of a positive correlation is economies of agglomeration. If we merge the evidence from economies of agglomeration--that productivity is high in large cities and the fact that minimum wage is high in large cities, we find a positive correlation between minimum wage and productivity. However, we must recognize that this does not mean that there is a causal relationship between minimum wage and productivity growth. We must pay attention to the presence of "large cities" as a factor that is common to both facts (Note 4).
Exit of Less Productive Firms Corresponds to the Truncation of the Productivity Distribution
Productivity growth resulting from the exit of less productive firms from the market (Hypothesis 2) is considered to correspond to the truncation of the productivity distribution. Figure 2 shows an image of the truncation of the productivity distribution around the time of a minimum wage hike that is caused by the exit of less productive firms.
It is true that if less productive firms are removed from the market, the average productivity of the overall Japanese economy rises. However, it should be kept in mind that the productivity levels of individual firms that remain in the market do not necessarily rise after a minimum wage hike. In other words, even if the average productivity increases at the macro level, individual firms' productivity, which should be the goal of the government's productivity revolution initiative, may not grow.
Another point that needs to be kept in mind is the employment status of workers previously employed by firms removed from the market. If new employment is created at highly productive firms due to the shift in the market caused by dissolution of less productive firms, it can be said that desirable resource reallocation has been achieved. Therefore, whether or not workers who lose their jobs at the less-productive firms are absorbed into new positions in the high-productive firms, is a key point.
As an economic theory concerning a selection of less-productive firms like the situation being described here, Melitz (2003) in the field of international trade provides important policy implications. Melitz (2003) analyzed the effects of a selection caused by trade liberalization using an approach that incorporates heterogeneity into firm productivity. As highly productive foreign firms enter the domestic market after trade liberalization, less productive firms that were only able to be competitive on the domestic level are forced to exit due to negative profits. However, as highly productive domestic firms can then increase their production volume through exports as a result of trade liberalization, workers who lose their jobs can be absorbed. The reallocation of resources from less productive firms to highly productive firms due to such selection increases economic welfare.
What effects will a selection caused by a minimum wage hike bring? While less productive firms that cannot meet the minimum wage threshold are expected to be removed from the market, it is unlikely that already highly productive firms will increase production volume and employment instantaneously. When debating policy, it is necessary to carefully examine whether or not a selection mechanism achieves an efficient production structure through the reallocation of resources from less productive firms to highly productive firms.
Summary: Toward Productivity Growth
For the question of whether or not a minimum wage hike causes productivity growth, my answer depends on which one of Hypothesis 1 or Hypothesis 2 is more dominant. If individual firms carry out reforms to increase productivity in response to a minimum wage hike, a productivity-increasing effect will be observed. On the other hand, if a minimum wage hike merely results in the exit of less productive firms from the market, a productivity-increasing effect will not be observed, as the hike will not lead to the productivity growth of individual firms. Moreover, as the minimum wage level rises, firm profits are expected to decline in the short term. The real effect of a minimum wage hike on productivity will vary across countries and firms, since the relative strength of the effects of Hypotheses 1 and 2 determine the total effect and also depend on firms' characteristics and market structure in different countries.
As increasing productivity is one of the top priority challenges, I believe that enhancing skills of individual workers is particularly important. However, unless firms offer wages commensurate with workers' skills, they cannot attract skilled workers, nor provide incentive for individual workers to invest in increasing human capital. Firms are trying to change the traditional Japanese employment practices, such as lifetime employment, seniority-based pay, and mass hiring of new graduates, in the drastically changing business environment. I hope that this report provides an opportunity for constructive discussion on how to tackle the challenge of increasing productivity.
- ^ Although Atkinson (2019b) argues that minimum wage should be universal nationwide, this report does not address this argument.
- ^ For example, Ministry of Health, Labour and Welfare provides business improvement subsidies for establishments that increase wages. The policy list provided by the government is available at the following URLs:
https://www.mhlw.go.jp/stf/seisakunitsuite/bunya/koyou_roudou/roudoukijun/zigyonushi/shienjigyou/index.html (As viewed on August 25, 2019)
https://www.kantei.go.jp/jp/singi/katsuryoku_kojyo/dai2/siryou2.pdf (As viewed on August 25, 2019)
- ^ A research paper published recently by Morikawa (2019) based on the analysis of panel data of firms obtained through the Basic Survey of Japanese Business Structure and Activities by the Ministry of Economy, Trade and Industry concluded that there is no clear evidence that past minimum wage hikes brought productivity growth to individual firms.
- ^ The question of to what degree factors can be identified among micro- and macro-level data is also emphasized in the explanation given by Kawaguchi (2018) with respect to the stagnant wage growth in recent years.
- Atkinson, David (2019a) "The Reason Why Raising the Minimum Wage Is the Global Norm," Toyo Keizai ONLINE (in Japanese)
https://toyokeizai.net/articles/-/263406 (As viewed on June 25, 2019)
- Atkinson, David (2019b) "The Fundamental Reason Why Minimum Wage Should be ‘Universal Nationwide,’" Toyo Keizai ONLINE (in Japanese)
https://toyokeizai.net/articles/-/264773 (As viewed on June 25, 2019)
- Kawaguchi, Daiji (2018) "Why Are Wages Not Rising?—Removal of Composition Bias Using Panel Data, Recruit Works Institute (ed.), Japanese Panel Study of Employment Dynamics—Thoughts on Working Styles in Japan 2018, Vol. 9 (in Japanese)
http://www.works-i.com/column/jpsed2018/kawaguchi (As viewed on June 25, 2019)
- Morikawa, Masayuki (2019) "Minimum Wages and Productivity: An Overview and Evidence from Japan," RIETI Policy Discussion Paper 19-P-012 (in Japanese)
- Melitz, Marc J. (2003) "The impact of trade on intra-industry reallocations and aggregate industry productivity," Econometrica, 71(6), pp. 1695-1725.
- Rizov, Marian, Richard Croucher and Thomas Lange (2016) "The UK National Minimum Wage's Impact on Productivity," British Journal of Management, 27(4), pp. 819-835
- Atkinson, David (2019a) "The Reason Why Raising the Minimum Wage Is the Global Norm," Toyo Keizai ONLINE (in Japanese)
August 27, 2019
Article(s) by this author
February 19, 2021［Priorities for the Japanese Economy in 2021 (January 2021)］
January 22, 2021［Newspapers & Magazines］
March 19, 2020［Priorities for the Japanese Economy in 2020 (January 2020)］
August 27, 2019［Policy Update］
February 12, 2019［Priorities for the Japanese Economy in 2019 (January 2019)］