Accompanied by intense public and academic debates, Germany introduced a national minimum wage 2015. Initially set at EUR 8.50 per hour, the minimum wage had a substantial impact on the wage distribution. As it was implemented during a period of sustained economic growth, the minimum wage did not result in significant job losses but rather led to a redistribution of employment towards higher-paying firms.
Is the burden of the minimum wage then borne by employers or consumers? Or do productivity gains offset the costs associated with the minimum wage? If employers cannot pass on the costs to their customers, their profits may decline, and economic rents may be lost. However, if the minimum wage stimulates productivity improvements within affected firms, any negative effects on workers, employers, or consumers can be mitigated or even turned into positive outcomes. A new IZA discussion paper by IWH researchers Mirja Hälbig, Matthias Mertens and Steffen Müller examines these questions of productivity and price adjustments.
Beyond the firm level, little is known about the overall impact of the minimum wage on market-level productivity. Aggregate productivity changes may arise from employment reallocation between firms with varying levels of productivity, potentially coupled with asymmetric productivity changes based on initial size or productivity level. Despite extensive minimum-wage research, no studies have analyzed the aggregate productivity effects of the minimum wage using microdata on firm productivity. A prominent previous study reports that employment reallocation occurred towards firms with higher predicted initial productivity, leading to improved allocative efficiency. However, direct observation of productivity remains elusive.
Productivity responses to the minimum wage are often overlooked
The new study reveals robust positive effects on wages per full-time equivalent (FTE) worker in both the manufacturing and service sectors. Accompanied by minor negative effects on employment in these industries, the total wage bill has increased. Notably, the impact on labor productivity (measured as value added per FTE) is even more substantial, with labor productivity effects of 5.6% and 10.6% observed in the manufacturing and service sectors, respectively.
These significant productivity improvements in affected firms have likely mitigated any adjustments in employment and output prices. Thus, understanding why the introduction of the German minimum wage has had minimal employment effects at the macro level relies heavily on comprehending these productivity enhancements.
It is worth noting that economists who anticipated substantial negative effects of the German minimum wage largely overlooked the potential productivity responses. Importantly, half of the strong difference-in-difference effect observed in the service sector can be attributed to a sudden reduction in labor productivity within the control group, suggesting that the labor inflow induced by the minimum wage resulted in a decline in average productivity for those firms.
Labor productivity can be boosted by gains in total factor productivity (TFP) or increased reliance on non-labor inputs. The authors do not find any effects of the minimum wage on investments per FTE. However, they observed that affected firms, compared to those in the control group, became more reliant on intermediate inputs. This increased outsourcing may partly explain the rise in productivity.
The detailed firm-product-level data for the manufacturing sector reveals that the direct effect of the minimum wage on firms’ revenue TFP (TFPR) amounts to 3.1%, while quantity TFP (TFPQ) increased by an additional 2.2% in the treated group compared to the control group. Consequently, output prices rose approximately 1% more in the treatment group. Taking price effects into account, the researchers conclude that firm-level labor productivity gains are primarily driven by improvements in true efficiency (TFPQ).
No evidence of increased allocative efficiency
With these firm-level findings established, the authors further investigate how reallocation affects aggregate productivity within industry-region cells. The notion that factor reallocation serves as a key driver of growth is prominent in various growth and trade models. Reallocation can be beneficial when production factors shift from less productive to more productive firms, ultimately raising aggregate productivity.
Consistent with previous research, the new study finds no employment effects at the level of aggregate industry-region cells. While the aggregate effects on wages and productivity are close to zero in the service sector, they are positive in German manufacturing. For every percentage point increase in wages needed to meet the minimum wage requirement, there is a 1.4% increase in manufacturing labor productivity. These aggregate productivity gains are entirely driven by within-firm productivity improvements. The study finds no evidence indicating that the minimum wage induces productivity-enhancing reallocation or increased allocative efficiency.