Effects of minimum wages on employment

Previous studies on the employment effect of minimum wages have produced mixed findings. These studies suggest the importance of keeping minimum wage at a moderate level to avoid trade-offs between wage increases and job losses as evidenced between East Germany and West Germany (Reference König and MöllerKönig and Möller, 2009), and labour substitutability between formal and informal sectors as evidenced in Indonesia (Reference Comola and De MelloComola and De Mello, 2011).

The positive employment effect of the minimum wage can be explained by the upwards-sloping labour-supply schedule resulting from employers’ monopsonistic hiring behaviour (Reference Card and KruegerCard and Krueger, 1994; Reference RansomRansom, 1993) and by the job-search model in which employees compare wages posted by different firms (Reference Burdett and MortensenBurdett and Mortensen, 1989; Reference Card and KruegerCard and Krueger, 1994). Continued employment growth following a minimum wage increase could be partially due to firms’ pricing strategy, passing the cost burden to consumers (Reference Card and KruegerCard and Krueger, 1994), reducing hours worked, increasing work intensity, cutting special payments and non-wage benefits, reducing labour turnover, hiring more qualified staff, not complying with minimum wage law (Reference Bruttel, Baumann and DütschBruttel et al., 2018) and raising labour productivity (Reference Riley and BondibeneRiley and Bondibene, 2017).

In China, the Labour Contract Law came into force on 1 January 2008, providing greater protection to workers in terms of employment security and income generation. The Law has implications for human resource planning by prospective and existing foreign investors. While implementation of this new labour law is consistent with the Chinese government’s intention to advance into a higher-wage, higher-technology nation, the Law has also triggered tremendous growth in informal employment in urban China, following reforms to the exploitative hukou system. Minimum wage policy revised during this period has focused on expanding coverage and increasing the amount paid. Despite burgeoning informal sector growth and the introduction of the minimum wage, reforms in the hukou system have reduced skilled–unskilled wage inequality in China, given the relatively greater capital intensity in the urban skilled than in the urban unskilled sector (Reference Pi and ZhangPi and Zhang, 2016). Thus, it is possible to expect a positive effect on employment of a minimum wage rise amid the influx of Chinese migrant workers into the informal sector.

Predictions that the introduction of a minimum wage will negatively affect employment are based on the perfectly competitive model assuming a product price increase (Reference Aaronson and FrenchAaronson and French, 2007). For example, a rise in the minimum wage adversely affected French youth employees (Reference Bazen and SkouriasBazen and Skourias, 1997) and young adults and individuals who had not completed high school, causing slower expansion in their employment than if the minimum wage had remained unchanged (Reference Clemens and StrainClemens and Strain, 2017). There is thus a need to weigh the benefits and costs of upwards adjustment in the minimum wage level (Reference Neumark and WascherNeumark and Wascher, 2015).

In China, the minimum wage rise following enforcement of the Labour Contract Law may have adversely affected manufacturing employment growth without leading to overall increases in aggregate unemployment (Reference Gallagher, Giles and ParkGallagher et al., 2013). The economic welfare of informal workers was compromised by incomplete enforcement of labour regulations and involvement from employment agencies and social security agencies (Reference CookeCooke, 2011), employer coercion on employees prompting to relinquish seniority claims via resignation, and the shifting of production to other lower-wage Chinese regions or Southeast Asian economies (Reference Wang, Appelbaum and DegiuliWang et al., 2009). Moreover, the Law provides greater social benefits and remuneration to urban workers than to migrant workers (Reference Cheng, Smyth and GuoCheng et al., 2015). Government intervention is thus pertinent to improving job prospects among informal migrant workers who have weak bargaining power and are less represented by trade unions (Reference Wang, Cooke and LinWang et al., 2016).

There are studies where the employment effect of minimum wage increase is minimal or non-existent. Reference MetcalfMetcalf (2008) in a British study attributes this phenomenon to an impact on hours rather than workers, employer wage setting and labour market frictions, offsets via the tax credit system, incomplete compliance, productivity improvements, price increases in consumer services and profits reduction. Similarly, Reference SchmittSchmitt (2013) attributes minimal impact to reductions in labour turnover when a higher minimum wage is paid, with resulting improvement in organisational efficiency, as well as a reduction in wages of higher earners, and smaller price increases.

However, empirical studies have placed less focus on the potential role of FDI, economic performance and labour productivity in accounting for the employment effects of a higher minimum wage. An increase in minimum wages affects operating costs for foreign investors, who in turn may adjust their hiring strategy. Yet such an increase improves labour productivity and the economic welfare of the society, which in turn may affect consumption and hiring. It is thus important to incorporate FDI, economic growth and labour productivity in analysing the nexus between minimum wages and employment.

Minimum wage, FDI and employment

FDI may serve as a moderator in either enhancing or mitigating the employment effect of the minimum wage. Foreign firms have tended to hire unskilled, blue-collar labour at lower pay than domestic firms in developing countries (Reference Coniglio, Prota and SericConiglio et al., 2015). However, Reference Payton and WooPayton and Woo (2014) argue that FDI inflows decrease with stricter labour regulations owing to rising costs of adherence, raising cost-efficiency concerns for foreign investors, even those intending to venture into developed Organisation for Economic Co-operation and Development (OECD) countries (Reference Alam and ShahAlam and Shah, 2013). So simply using minimum wages as the measurement of unit labour costs will definitely predict a reduced number of FDI projects in a country, as found in a hospitality industry study (Reference FalkFalk, 2016).

Meanwhile the impact of FDI on employment creation in host countries has been demonstrated, for example, in the Malaysian manufacturing sector (Reference Bekhet and MugablehBekhet and Mugableh, 2016) and in production-supporting ancillary sectors in Fiji’s economy (Reference Jayaraman and SinghJayaraman and Singh, 2007). However, the magnitude of FDI-led direct and indirect employment growth may be negligible or even reduced when, for example, labour productivity is high, the value added of output is low, or domestic industrial linkage is limited, or when domestic investment is crowded out, as in the case of Vietnam (Reference JenkinsJenkins, 2006). The channels through which FDI and employment are related are strategic asset-seeking FDI that creates new jobs for educated labour (Reference Rozen-BakherRozen-Bakher, 2017), and non-exporting and labour-intensive FDI that increases employment elasticity following changes in capital input and output (Reference Chen, Li and YinChen et al., 2016).

Previous studies have tended to emphasise the adverse effect of minimum wages on FDI and the mixed effect of FDI on employment. Based on this reasoning, one hypothesis is that the employment effect of an increase in the minimum wage is conditional on the level of FDI. This hypothesis is justifiable on the ground that FDI providers are cost-conscious when facing with increasing minimum wages in host countries. An increase in the minimum wage in a host country with higher amount of FDI inflows may trigger foreign capital withdrawal, exacerbating employment reduction. However, should the effect of minimum wage on employment be positive, an increase in asset-seeking FDI inflows may further enhance employment creation momentum in the host country. The present study tests these hypotheses.

Minimum wage, economic growth and employment

The growth effect of a minimum wage increase may not be destructive because a higher minimum wage leads to higher gross domestic product (GDP) per capita (Reference Bhorat, Kanbur and StanwixBhorat et al., 2017), whereas a lower minimum wage reduces the economic welfare of each market player (Reference Cahuc and MichelCahuc and Michel, 1996). Human capital theory attributes this positive GDP effect to human capital accumulation by unskilled workers displaced following a minimum wage increase (Reference Cahuc and MichelCahuc and Michel, 1996).

Economic growth has been linked to employment creation through increased production via new economic sectors (Reference Saviotti and PykaSaviotti and Pyka, 2004). However, a substitution effect may result in a negative employment effect of economic growth (Reference SotoSoto, 2009). Capital and high-skilled labour will be preferred over both traditionally skilled and unskilled labour following technology-led economic growth (Reference Jung, Lee and HwangJung et al., 2017).

The above analysis suggests a positive effect of minimum wages on economic growth and a mixed effect of economic growth on employment. It can therefore be hypothesised that the relationship between minimum wages and employment depends on the level of economic growth. Reference Dube, Lester and ReichDube et al. (2010) have particularly criticised studies for producing spurious negative employment effects of minimum wage policies by not considering local economic conditions. Rather, economic expansion may enhance the employment creation momentum of a minimum wage rise while also exacerbating the employment reduction effect of minimum wage rise through a substitution effect.

Minimum wage, labour productivity and employment

The effect of a minimum wage on employment may also be conditional on the level of labour productivity. Reference MetcalfMetcalf (2008) argues that productivity improvement had little or no apparent effect on employment when the British national minimum wage (NMW) was introduced in 1999. British firms reacted by increasing total factor productivity (TFP) without Bodn reducing their workforce or resorting to capital-labour substitution, consistent with theories of organisational change, training and efficiency wages (Reference Riley and BondibeneRiley and Bondibene, 2017). A NMW may thus enhance aggregate productivity, specifically for the low-paying sector, justifying management practice and public policy of offering higher wage incentives (Reference Rizov, Croucher and LangeRizov et al., 2016). Productivity improvement is a more popular form of adjustment to minimum wage rises than employment reduction, as observed by Reference Bodnár, Fadejeva and IordacheBodnár et al. (2018) in Central and Eastern European countries. In China, this adjustment channel has involved better inventory management and greater capital investment (Reference Mayneris, Poncet and ZhangMayneris et al., 2018), with productive firms driving out unproductive ones (Reference Mayneris, Poncet and ZhangMayneris et al., 2014). Chinese firms have thereby been able to remain profitable without cutting back on hiring amid minimum wage increases.

However, Reference Alvarez and FuentesAlvarez and Fuentes (2018) argue that a minimum wage has a negative effect on TFP as a result of labour adjustment costs. Such adjustment costs may be a barrier to firms wishing to switch to capital-intensive production when facing higher minimum wages, adversely affecting labour productivity. This constraint is specifically applicable to industries or occupations with an inelastic demand for labour (Reference WimmerWimmer, 2000). Such firms may not respond to a minimum wage rise by adjusting their production structure, with anomalous employment effects.

Model specification

Empirical studies reviewed above highlight the potential employment effect of the minimum wage. Besides the minimum wage, FDI, economic growth and labour productivity have affected employment levels directly, as well as indirectly via the minimum wage. Thus, the baseline model employed in this study can be represented by equation (1) below

(1) $EMP=f(MW,FDI,PCGDP,PROD)$

where $EMP$ refers to total employment for each province and $MW$ indicates the monthly minimum wage, measured in yuan or Renminbi (RMB), which varies across provinces and within the same province. We include FDI as a variable to capture the employment opportunity opened up for Chinese workers following China’s entry into WTO. $PCGDP$ is the amount of per capita gross domestic products (GDP) measured in yuan per person, while PROD denotes labour productivity as measured by PCGDP per employment.

However, the MW, FDI, PCGDP and PROD variables are likely to be endogenous, possibly because of the feedback effect running from EMP to MW, FDI, PCGDP and PROD. Therefore, this study uses generalised method-of-moments (GMM) estimations to deal with endogeneity and simultaneity bias. Data for 31 provinces in China ranging from 2004 to 2015 are used to investigate the relationship among variables. By taking into account the dynamic effect of employment, where the total employment in a current year is influenced by the total employment in the previous year, the impact of the minimum wage and other variables on employment in dynamic panel data can be expressed as follows

(2) $\ln EM{P}_{it}=\alpha \ln EM{P}_{it-1}+{\beta }_1\ln M{W}_{it}+{\beta }_2\ln FD{I}_{it}+{\beta }_3\ln PCGD{P}_{it}+{\beta }_4\ln PRO{D}_{it}+{\eta }_i+{\epsilon }_{it}$

where $\alpha$ indicates the dynamic effect of lagged dependent, ${\eta }_i$ is the unobserved province-specific effect term, ${\epsilon }_{it}$ is the error term, $i$ is the province index and $t$ is the time index.

To anticipate possible differences in employment effect between higher and lower minimum wage levels, FDI, per capita GDP and labour productivity, we strategise our study by interacting the minimum wage, FDI, per capita GDP and labour productivity with the levels of minimum wage, FDI, per capita GDP and labour productivity, respectively. Differences in level are captured by dummy variables MWStatus, FDIStatus, PCGDPStatus and PRODStatus that indicate whether the minimum wage, FDI, per capita GDP and labour productivity in a particular province in a particular year are above (denoted by a dummy of ‘1’) or below (denoted by a dummy of ‘0’) the average among all provinces in that particular year. However, we eliminate the dummy variable itself as categorical data to avoid the multicollinearity problem.^{Footnote 1} The following equations convey the impact of the level of minimum wage, FDI, per capita GDP and labour productivity on employment

(3.1) $\begin{array}{c}\ln EM{P}_{it}={\alpha }_1\ln EM{P}_{it-1}+{\beta }_{11}\ln M{W}_{it}+{\beta }_{21}\ln FD{I}_{it}+{\beta }_{31}\left(\ln M{W}_{it}\times MWStatu{s}_{it}\right)\\ +{\beta }_{41}\ln PCGD{P}_{it}+{\beta }_{51}\ln PRO{D}_{it}+{\eta }_i+{\epsilon }_{1it}\end{array}$

(3.2) $\begin{array}{c}\ln EM{P}_{it}={\alpha }_2\ln EM{P}_{it-1}+{\beta }_{12}\ln M{W}_{it}+{\beta }_{22}\ln FD{I}_{it}+{\beta }_{32}\left(\ln FD{I}_{it}\times FDIStatu{s}_{it}\right)\\ +{\beta }_{42}\ln PCGD{P}_{it}+{\beta }_5\ln PRO{D}_{it}+{\eta }_i+{\epsilon }_{2it}\end{array}$

(3.3) $\begin{array}{c}\ln EM{P}_{it}={\alpha }_3\ln EM{P}_{it-1}+{\beta }_{13}\ln M{W}_{it}+{\beta }_{23}\ln FD{I}_{it}+{\beta }_{33}\ln PCGD{P}_{it}\\ +{\beta }_{43}\left(\ln PCGD{P}_{it}\times PCGDPStatu{s}_{it}\right)+{\beta }_{53}\ln PRO{D}_{it}+{\eta }_i+{\epsilon }_{3it}\end{array}$

(3.4) $\begin{array}{c}\ln EM{P}_{it}={\alpha }_4\ln EM{P}_{it-1}+{\beta }_{14}\ln M{W}_{it}+{\beta }_{24}\ln FD{I}_{it}+{\beta }_{34}\ln PCGD{P}_{it}\\ +{\beta }_{44}\ln PRO{D}_{it}+{\beta }_{54}\left(\ln PRO{D}_{it}\times PRODStatu{s}_{it}\right)+{\eta }_i+{\epsilon }_{4it}\end{array}$

Next, we further investigate the role of FDI, per capita GDP and labour productivity in accounting for the effect of minimum wages on employment by interacting MW with FDI PCGDP and PROD, respectively. The following equations epitomise the interaction model of these variables:

(4.1) $\begin{array}{c}\ln EM{P}_{it}={\alpha }_5\ln EM{P}_{it-1}+{\beta }_{15}\ln M{W}_{it}+{\beta }_{25}\ln FD{I}_{it}+{\beta }_{35}\left(\ln M{W}_{it}\times \ln FD{I}_{it}\right)\\ +{\beta }_{45}\ln PCGD{P}_{it}+{\beta }_{55}\ln PRO{D}_{it}+{\eta }_i+{\epsilon }_{5it}\end{array}$

(4.2) $\begin{array}{c}\ln EM{P}_{it}={\alpha }_6\ln EM{P}_{it-1}+{\beta }_{16}\ln M{W}_{it}+{\beta }_{26}\ln FD{I}_{it}+{\beta }_{36}\left(\ln M{W}_{it}\times \ln PCGD{P}_{it}\right)\\ +{\beta }_{46}\ln PCGD{P}_{it}+{\beta }_{56}\ln PRO{D}_{it}+{\eta }_i+{\epsilon }_{6it}\end{array}$

(4.3) $\begin{array}{c}\ln EM{P}_{it}={\alpha }_7\ln EM{P}_{it-1}+{\beta }_{17}\ln M{W}_{it}+{\beta }_{27}\ln FD{I}_{it}+{\beta }_{37}\left(\ln M{W}_{it}\times \ln PRO{D}_{it}\right)\\ +{\beta }_{47}\ln PCGD{P}_{it}+{\beta }_{57}\ln PRO{D}_{it}+{\eta }_i+{\epsilon }_{7it}\end{array}$

In addition, this study further investigates the role of levels of FDI, per capita GDP and labour productivity in accounting for the employment effect of the minimum wage. We anticipate that FDI, per capita GDP and labour productivity that are above the average will mitigate the negative effect of the minimum wage on employment. Therefore, we strategise our research by using models of interaction between MW and FDIStatus, PCGDPStatus and PRODStatus, respectively. The models can be written as follows

(5.1) $\begin{array}{c}\ln EM{P}_{it}={\alpha }_8\ln EM{P}_{it-1}+{\beta }_{18}\ln M{W}_{it}+{\beta }_{28}\ln FD{I}_{it}+{\beta }_{38}\left(\ln M{W}_{it}\times FDIStatu{s}_{it}\right)\\ +{\beta }_{48}\ln PCGD{P}_{it}+{\beta }_{58}\ln PRO{D}_{it}+{\eta }_i+{\epsilon }_{8it}\end{array}$

(5.2) $\begin{array}{c}\ln EM{P}_{it}={\alpha }_9\ln EM{P}_{it-1}+{\beta }_{19}\ln M{W}_{it}+{\beta }_{29}\ln FD{I}_{it}+{\beta }_{39}\left(\ln M{W}_{it}\times PCGDPStatu{s}_{it}\right)\\ +{\beta }_{49}\ln PCGD{P}_{it}+{\beta }_{59}\ln PRO{D}_{it}+{\eta }_i+{\epsilon }_{9it}\end{array}$

(5.3) $\begin{array}{c}\ln EM{P}_{it}={\alpha }_{10}\ln EM{P}_{it-1}+{\beta }_{110}\ln M{W}_{it}+{\beta }_{210}\ln FD{I}_{it}+{\beta }_{310}\left(\ln M{W}_{it}\times PRODStatu{s}_{it}\right)\\ +{\beta }_{410}\ln PCGD{P}_{it}+{\beta }_{510}\ln PRO{D}_{it}+{\eta }_i+{\epsilon }_{10it}\end{array}$

Equations (2)–(5.3) above are estimated using GMM and the results are presented in Table 1.

Table 1. The determinants of employment in China: Two-step system-GMM.

FDI: foreign direct investment; PCGDP = amount of per capita gross domestic product; PROD: labour productivity as measured by PCGDP per employment.

a AR(2) is the test for autocorrelation.

b J-test is the test for overidentification.

Collapse of lag length technique is used to overcome the instrument proliferation problem as proposed by Reference RoodmanRoodman (2009).

All variables are expressed in their natural logarithmic form.

***, ** and * denote significance level at 1%, 5% and 10%, respectively.