Working Paper No.18, Yi Huang, etc. Minimum Wage and Firm Employment: Evidence from China
Huang, Yi; Prakash Loungani; Wang, Gewei
Published: 2014/4/16 15:25:15    Updated time: 2014/4/25 18:14:28
Abstract: This paper studies how minimum wage policies affect firm employment in China using a unique county level minimum wage data set matched to disaggregated firm survey data. We investigate both the effect of imposing a minimum wage, and the effect of the policies that tightened enforcement in 2004. We find that the average effect of minimum wage changes is modest and positive, and that there is a detectable effect after enforcement reform. Firms have heterogeneous responses to minimum wage changes which can be accounted for by differences in their wage levels and profit margins: firms with high wages or large profit margin increase employment, while those with low wages or small profit margin downsize. The increase in enforcement of China’s minimum wage in 2004 has since amplified this heterogeneity, which implies that labor regulation may reduce the monopsony rent of firms. Our results provide evidence for the theoretical predictions of the positive minimum wageemployment relationship in a monopolistic labor market.
Keywords: China, employment, minimum wages, heterogeneous effect

This version: April 16, 2014. (Preliminary, comments welcome)



    Yi Huang, The Graduate Institute, Geneva;

    Prakash Loungani, IMF;

    Gewei Wang, The Chinese Univ. of Hong Kong.


* We thank Olivier Blanchard, Richard Portes and Qiren Zhou for invaluable guidance and generous support. We are indebted to Ministry of Human Resources and Social Security of China, Shi Li, Chunbin Xing (BNU and IZA), Ming Lu (Fudan) and Quheng Deng (CASS), who provided us the data and helpful suggestions. We benefited from Dmitriy Skugarevskiy, Pengtu Ni and Hang Zhang for phenomenal research assistance. We are grateful to Jean-Louis Arcand, Kathleen Beegle, Nicolas Berman, Nick Bloom, Zhao Cheng, Jeffrey Dickinson, Slobodan Djajic, Freeha Fatima, John Giles, Harald Hau, Fan He, Pravin Krishna, Carl Lin, Ghazala Mansuri, Hong Ma, Jaime Marquez, David Locke Newhouse, Ugo Panizza, Jim Riedel, Alexandre Swoboda, Cedric Tille, Heiwai Tang, Hui Tong, Fabian Valencia, Lore Vandewalle, Pengfei Wang, Binzhen Wu, Zhiwei Xu and Du Yang for their helpful comments. We also thank seminar participants at the IHEID, IMF “Job & Growth” working group, World Bank “Labor and Poverty Practice Group”, SAIS, Tsinghua University, Fudan University, Ministry of Human Resources and Social Security-BNU “Minimum Wage” workshop, Shanghai Jiaotong University and CEPR. The views in the paper are those of the authors and do not necessarily reflect those of the IMF. Yi Huang is the corresponding author.



The substantial literature on the effects of the minimum wage arrives at little consensus on the impact on a firm’s employment decisions. While Brown (1999) finds that changes in the minimum wage have a negative impact on employment, Card and Krueger (1995) and Dickens et al. (1999) find an insignificant impact. A literature review shows that the evidence impacts of the minimum wage is quite mixed (Neumark and Wascher, 2007). 
One of the challenges in measuring the impact of the minimum wage is that the impact may be quite heterogenous across firms and workers. For instance, some recent research for the UK has found that the enforcement of minimum wage policies raises employee wages but also significantly reduces profitability for low-wage firms, especially those in industries with relatively high market power (Draca et al., 2011).
Another challenge comes from the endogenous nature of government policies. The response of firm employment to minimum wages depends on the shape of the labor demand schedule in the range of the minimum. Freeman (2010) argues that the evidence which shows that employment responses are often negligible does not mean that demand curves do not slope downward, or that a high minimum wage cannot reduce employment. Rather, it suggests that governments set minimum wages while considering the risk that minima can cause more harm than good.
In this paper, we provide evidence on the impact of the minimum wage on employment using a novel data set that allows us to confront both of these challenges. In China, the minimum wage policy was initially introduced in 1994 and formally approved shortly thereafter by the National Congress to be part of the labor laws. However, the design and setting of the minimum wage differs across the counties in China. In our paper, we thus start with a detailed examination of minimum wage determinants using data from more than 2,800 counties. This captures changes for every province in China. We show that the setting of the county-level minimum wage is influenced by living costs, secondary industry size, and fixed investment growth (proxy for future growth potential). This first-stage analysis of the likely determinants of the minimum wage allows us to alleviate concerns about endogenous relationship between government policy and firm employment decisions.
After controlling for the characteristics that govern the setting of the minimum wages, we explore the impact of the minimum wage on firm employment decisions. In this part of the paper we take advantage of rich firm-level data from a large representative industry survey covering more than 95 percent of China’s manufacturing output and 67 percent of manufacturing employment.
We find that the average effects of minimum wage on employment are positive but negligible. The impact on employment, however, does vary across firms, depending on their profit margins and wage levels. After a minimum wage hike, firms with high wages and large profit margins increase employment while those with low wages and small profit margins downsize.
We also exploit an unanticipated minimum wage policy reform in 2004 to test whether the degree of enforcement affects estimated of the impact of the minimum wage on employment. We find that the increased enforcement from 2004 onwards amplified this heterogenous effect, suggesting that the increased enforcement may have reduced the monopsony rent of firms.
Rising labor costs in China are a widely discussed topic among policymakers and economists. In the period from 1998 to 2010, the average growth rate of real wages was 13.8 percent, which exceeds the real GDP growth rate as well as the growth of labor productivity(Li et al., 2012). Among labor market policy tools, minimum wage policy has been considered to be a major force driving increases in wages and reductions of employment. A majority of the recent studies, following Neumark (2001), use the nice provinces urban household survey data to review the effect of minimum wage policy. Wang and Gunderson (2011) show that minimum wage has negative employment effects in slower growing regions, with even greater negative effects in non-state- owned organizations. Fang and Lin (2013) find that minimum wage changes have significant effects on employment in the more prosperous Eastern part of China, resulting in employment reduction for females, young adults, and less-skilled workers.
To the best of our knowledge, this is one of the first studies to show a heterogeneous effect of minimum wage on employment using a county level data set which tracks firms across China using an industry survey. We provide new empirical evidence on the effect the minimum wage policy and reform have on firm employment, and suggest a new framework to study how corporate decisions respond to labor market shocks.
This paper is related to the growing literature which reconsiders the impact on firm employment using local controls across US states and incorporating time varying heterogeneity. Allegretto et al. (2011) and Allegretto et al. (2013) have studied explicitly the lagged effects, wage group dynamics, and shifts in the employment flow using credible research designs. Hirsch et al. (2011) and Schmitt (2013)show no discernible effect on employment by firm’s productivityenhancing activities with the productivity-competition model. Our paper is the first to document heterogeneous effects connected to wage and profit margin differences using a monopsony model.
In our paper, we study how the Chinese government adjusts minimum wage policy to avoid the paradox of costly enforcement, and maintain credible commitment of minimum wage at developing countries (Basu et al., 2010). The minimum wage policy of China provides new opportunities to evaluate the design and enforcement of labour market policy in emerging market countries, an issue which is also explored in (Bell (1997); Harrison and Leamer (1997); Lemos (2004); Lemos (2009)).
In addition, the primary implication of our study is that the effect of minimum wages are positive and small in magnitude during the period of rising minimum wages and increased enforcement in China. Policy makers must weigh the trade-off between the redistribution of welfare, and labour market flexibility(Sobel (1999); Blanchard et al. (2013)).
We discuss the minimum wage policy in the next section. The remainder of our paper is structured as follows. We present theoretical background relating to labor market competition, and minimum wage effects in Section 3; describe the firm level data and minimum wage data as well as the other regional macro variables in Section 4, and present our empirical strategy for the minimum wage determinants and firm employment estimation in Section 5. In Section 6, we provide detailed results, and discuss the general effects and heterogeneous effects by wage group. In section 7, we explore the sensitivity of employment to an enforcement shock and investigate further robustness check. Section 8 concludes.
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