Working Paper No. 39: Carl Lin, Myeong-Su Yun: The Effects of the Minimum Wage on Earnings Inequality: Evidence from China

Lin, Carl; Yun, Myeong-Su
Published: 2015/11/7 15:37:03    Updated time: 2015/11/7 15:37:39

Abstract: The minimum wage has been regarded as an important element of public policy for reducing poverty and inequality. Increasing the minimum wage is supposed to raise earnings for millions of low-wage workers and therefore lower earnings inequality. However, there is no consensus in the existing literature from industrialized countries regarding whether increasing the minimum wage has helped lower earnings inequality. Studying the effect of the minimum wage on the earnings distribution is more complicated in developing countries such as China than in industrialized countries owing to the presence of large informal sectors in urban areas, large pools of surplus labor in rural areas, and difficulties in ensuring compliance with minimum wage legislation. China has recently exhibited rapid economic growth and widening earnings inequality. Since China promulgated new minimum wage regulations in 2004, the magnitude and frequency of changes in the minimum wage have been substantial, both over time and across jurisdictions. The growing importance of research on the relationship between the minimum wage and earnings inequality and its controversial nature have sparked heated debate in China, highlighting the importance of rigorous research to inform evidence-based policy making. We investigate the contribution of the minimum wage to the well-documented rise in earnings inequality in China over the period from 2004 to 2009 by using city-level minimum wage panel data and a representative Chinese household survey, and we find that increasing the minimum wage exerts beneficial effects on the earnings distribution—by reducing the earnings gap between the median and the bottom decile—over the analysis period.
Keywords: Minimum Wage, China, Earnings Inequality

 Authors:

        Lin, Carl ---- China Institute for Income Distribution;

        Myeong-Su Yun ---- Tulane University and IZA;

 

1. Introduction

Since the reform and opening-up policy in 1978, China’s economy has been growing remarkably at a rate of at least 9.5% per year. As the economy has grown, Chinese workers’ earnings have also increased rapidly over the same period. According to the latest figures from the National Bureau of Statistics of China (NBS), disposable earnings per capita have risen substantially—more than 70-fold—over the past few decades in urban China, rising from 343 RMB in 1978 to 24,565 RMB in 2012, while net earnings per capita in rural China have grown 60-fold, increasing from 134 RMB in 1978 to 7,917 RMB in 2012 (National Bureau of Statistics of China 2013).

As the Chinese economy has rapidly grown, the earnings distribution has deteriorated. For example, the urban-to-rural earnings per capital ratio increased from 2.57 in 1978 to 2.90 in 2001 and further to 3.10 in 2012. The Gini coefficient, a commonly used measure of inequality, was very low level in 1978, at .16 and .22 for urban and rural areas, respectively (Li and Zhao 1999). However, as shown in Figure 1, China’s overall Gini coefficient began to rise from .376 in 1988 to .439 in 1995 (Wang 2007) and increased further to .454 and .490 in 2002 and 2007, respectively (Li and Luo 2011).

 

 

The deterioration of the earnings distribution and growing gap between the rich and the poor has engendered challenges to economic development and social stability in China. As shown by the experience of developed countries, public polices, such as tax reforms, can play an essential role in countering deteriorating inequality. Since the early 2000s, the Chinese government has intensively promulgated a series of policies, such as aid to the poor, rural minimal social security, and the minimum wage policy. Among these policy initiatives, the minimum wage policy is the most controversial.

The contentiousness of the debate on the minimum wage policy in China arises from the difficulty of measuring its effects on employment, wages, and the earnings distribution, among others. However, the initial evidence suggests that the magnitude and frequency of changes to the minimum wage have been substantial both over time and across different jurisdictions, particularly since 2004. These large variations both across jurisdictions and over time facilitate our estimation of minimum wage effects on inequality in China. For example, in January 2004, China promulgated new minimum wage regulations that required local governments to introduce a minimum wage increase at least once every two years, that extended coverage to self-employed and part-time workers, and that quintupled the penalties for violations or noncompliance. The new regulations entered into force in March 2004, engendering frequent and substantial increases in the minimum wage in the years that followed.

 

 

Figure 2 shows the nominal and real minimum wage (monthly average) in China from 1995 to 2012, as well as those of the corresponding provinces that raised the minimum wage standards for each year and the moving average over the same period.4 Between 1995 and 2003, the average nominal minimum wage increased steadily from 169 RMB to 301 RMB, amounting to 78% growth over 9 years. However, since China promulgated the new minimum wage regulations in 2004, the nominal minimum wage has increased rapidly by more than 200%, reaching 944 RMB in 2012.5 The real minimum wage grew at a slower pace before 2004 and began to rise thereafter. Furthermore, as shown by the moving average curve in Figure 2, there is an apparent rise in the number of provinces that raised the minimum wage standards in 2004, indicating that minimum wage adjustments have become more frequent since 2004.

 

 

Figure 3 shows the trends in the effective minimum wage (defined as the differential between the log minimum wage and the log median earnings), earnings inequality (defined as the standard deviation of log earnings), the log difference between the top decile (p90) and the median (p50) of the earnings distribution and the log difference between the median and the bottom decile (p10). As the figure shows and as documented by numerous studies, inequality in China rose gradually during the period 2002-2009, peaking in 2008. More important, the effective minimum wage rose sharply between 2004 and 2008, whereas both earnings gaps (p90- p50 and p50-p10) grew substantially over the same period.

Although the literature widely documents numerous aspects of the minimum wage and its role in the labor market, there is no consensus regarding whether the minimum wage has beneficial effects for the earnings distribution (Neumark and Wascher 2008). Moreover, research on the effect of the minimum wage on inequality in developing countries is scant. Accordingly, this study examines whether increasing the minimum wage contributes to or counteracts increasing inequality. China provides a particularly interesting context for such a study since China has experienced both rising inequality and a rising minimum wage (nominal and real), whereas countries such as the U.S. and Mexico have experienced rising wage inequality with a declining minimum wage (real).

Using OLS and IV panel regressions at the aggregated city level, we first examine the effect of minimum wage changes on the earnings gaps at the bottom and upper end of the earnings distribution as well as the extent of such an effect. Our analysis shows that minimum wage increases significantly help reduce earnings gaps, particularly at the bottom end of the distribution. Next, to measure the contribution of minimum wage changes to the change in earnings inequality, we construct a counterfactual scenario to capture how China’s earnings distribution would have evolved without the rise in the minimum wage. The difference between the observed and the counterfactual scenario is the real effect of the minimum wage. Indeed, we find that the contribution of minimum wage changes in reducing inequality is substantial, particularly at the bottom end of the earnings distribution. That is, had it not been for the increase in the minimum wage, the earnings gap at the bottom end of the earnings distribution would have been larger. In robustness checks, the decomposition results for Gini coefficients and the variance of log earnings also suggest that the minimum wage substantially helps reduce inequality in the period of our analysis.

The remainder of this study is organized as follows. We briefly review the literature in Section 2 and provide a review of the development of the minimum wage in China in Section 3. Section 4 provides details regarding the data and research design. In Section 5, we present and discuss the empirical results. Section 6 presents the conclusions.