Working Paper No. 33, Tobias Haepp, Carl Lin, How Does the Minimum Wage Affect Firm Investments in Fixed and Human Capital? Evidence from China

Haepp, Tobias; Lin, Carl
Published: 2015/8/7 13:34:43    Updated time: 2015/8/8 11:10:10

Abstract: This paper empirically analyzes the impact of the Chinese minimum wage regulations on the firm decision to invest in physical and human capital. We exploit the geographical and inter-temporal variation of county-level minimum wages in a large panel data set of Chinese firms covering the introduction of the new Chinese minimum wage regulations in 2004. In our basic regressions including all Chinese firms, we find significant negative effects of the minimum wage on human capital investment rates and significant positive effects on fixed capital investment rates. When grouping firms by their ownership structure, we find that all company groups - including state-owned and foreign-owned companies - have reduced their human capital investments, while only Chinese privately owned companies have increased their fixed capital investment rates.
Keywords: Minimum wages, investment, fixed capital, human capital

(This paper was received by Review of Development Economics R&R)

Authors:

Tobias Haepp

Graduate Institute of National Development;

National Taiwan University Chung-Hua Institution for Economic Research (CIER)

Carl Lin

Department of Economics, Beijing Normal University;

Institute for the Study of Labor (IZA)       

 

1. Introduction

 

As part of its endeavour to ensure the provision of basic living standards of its work force, China accepted the ILO Minimum Wage Fixing Convention in 1984 and issued the ‘Enterprises Minimum Wage Regulations’ in 1993. In 2004, the government passed new minimum wage regulations, requiring each province to increase its minimum wage at least biannually and increasing the fines for non-compliant companies. The frequency and scale of minimum wage adjustments across the Chinese economy has subsequently increased significantly. In those parts of the country that had implemented a minimum wage by 1996, nominal minimum wage levels increased by 90.42% until 2004. This was followed by an increase of 178.05% in the subsequent years until 2012. According to data from the Urban Household Survey used in Fang and Lin (2013), 8.91% of urban workers and 57.01% of urban female workers were earning the minimum wage or less between 2004 and 2009. While data on rural migrant workers are scarce, the effect of the minimum wage on this group is estimated to be even larger due to their predominance in low-wage sectors (Wang and Gunderson, 2011).

The expansion of the Chinese minimum wage system has been accompanied by an ongoing controversy regarding the suitability of the policy for the Chinese economy. Pro ponents argue that it is a necessary means to warrant sufficient living standards for vulnerable workers and introduces incentives for companies to upgrade excessively labor intensive production technology, while opponents of the minimum wage policy argue that the policy interferes with the transition to a market economy and that it raises production costs, in turn harming the international competitiveness of Chinese companies (Cooke, 2005; Wang and Gunderson, 2011). Recent research has investigated the effect of the minimum wage on employment and found adverse effects for parts of the Chinese labor force, including female labor (Wang and Gunderson, 2012; Jia, 2014), workers in non state owned enterprises and slow-growing regions (Wang and Gunderson, 2011) as well as young adults and low-skilled workers (Fang and Lin, 2013). On the other hand, Huang et al. (2014) employ firm data and find that firms with higher wage levels and larger profit margins increase their employment levels. The effect of the Chinese minimum wage policy on firm behaviour has received limited attention thus far and the current work aims make a contribution to fill this gap in the literature. We focus on investment behaviour, which is a direct determinant of the long term competitiveness of companies. We first analyze whether the cost burden imposed on companies through an increase in minimum wages has harmed company competitiveness in terms of the ability to invest in fixed capital. We then investigate how minimum wages affect the ability of companies to invest in human capital. Investment in human capital is of particular importance in the Chinese case, since it is a key channel to achieve the envisioned skill-upgrading in the industrial sector. The theoretical predictions regarding the effect of an exogenous change in the price of labor due to an increase in the minimum wage differs between standard neoclassical models and non-competitive models of the labor market. Based on standard neoclassical theory, an increase in the price of labor induces firms to substitute away from affected workers. The effect on capital thus depends on the degree of substitutability or com plementarity between the two factors of production. Moreover, the cost burden imposed on companies through minimum wages potentially affects capital investments via a scale effect as product prices rise and the level of output drops. The overall effect of an increase in the minimum wage on capital investment therefore depends on the direction and size of the substitution effect and the size of the scale effect.

For the theoretical effect of minimum wage hikes on company training investments, the standard human capital model with competitive labor markets based on Becker (1993) predicts a negative effect on company training expenditures since workers finance their on-the-job training through lower wages. In this case, the introduction of a minimum wage reduces the level of training since it restricts the pay reductions workers can accept to finance the training (Rosen, 1972; Feldstein, 1973).

More recently, non-competitive models of the labor market have been developed in which labor market frictions and asymmetric information lead to a wedge between wages and marginal productivity (Acemoglu and Pischke, 1999). In these models it can be profitable for a firm to retain a worker despite the increase in wage costs if it can in crease worker productivity through investments in capital or training and claim the re-sulting rents. Contrary to the results from traditional models, a compression of wages through minimum wages may thus induce an increase in fixed capital investments and firm-sponsored training in non-competitive models (Pischke, 2005; Acemoglu and Pischke, 2003). Hybrid models of the labor market that relax the assumption of perfect competition generally predict that the incidence of the minimum wage varies with the degree of competition and the amount of rents that can be allocated.

Currently, there is an ongoing debate reinforced by mixed empirical evidence about which model provides a better fit for empirical data. The present work aims to contribute to this debate by jointly analyzing the effect on the two types of investments and by providing the first piece of evidence on the link between the minimum wage and firm financed training from a developing economy.

In order to empirically analyze our research question, we employ the widely used Chinese Annual Census of Industrial Firms (CASIF) panel data set which covers the introduction of the new minimum wage regulations in 2004. We include the three years leading up to the reform as well as the four subsequent years during which the magnitude and frequency of minimum wage adjustments across China increased significantly. We then estimate dynamic panel data regressions accounting for the inter-temporal adjustment of fixed capital investments as well as logit and tobit panel data regressions accounting for the incidence of censoring of our dependent variable in the human capital regressions. We find that the minimum wage hikes have caused an increase in fixed capital investments, while they have imposed a negative effect on human capital investments. Our results therefore point to a substitution effect between the two types of investments due to the increase in labor costs, which is somewhat supportive of the predictions based on neoclassical models of the labor market.

The rest of this paper is structured as follows. Section II reviews the empirical literature on the effects of minimum wages on companies and their investment behaviour. Section III outlines our research methodology. Section IV introduces the minimum wage and the firm data used in this paper. Section VI provides our results, while section VII elaborates our research outcomes and concludes the paper.