Chapter 7: Monitoring the effects of minimum wages

7.6 Effects on labour productivity

Recent studies have shown that minimum wages not only help to reduce wage dispersion and to channel productivity gains into higher wages, but they also can contribute to higher labour productivity – both at the enterprise level and at the aggregate economy-wide level.

At the enterprise level

At the enterprise level, workers may be motivated to work harder. Various studies have supported the hypothesis that first by Akerlof in 1982 that employees consistently provide higher effort levels in response to higher wages, the  so-called “efficiency wage” theory.

Workers may also stay longer with their employer, gaining valuable experience and encouraging employers and employee to engage in productivity-enhancing training. Dube, Lester and Reich (2012) attribute reduced turnover for restaurant workers in California to the effect of the minimum wage, which reduces wage competition between low-paying enterprises. When employers can better retain their workforce, workers can learn on the job and be trained to become more productivity over time.

Researchers have pointed out that productivity increases may be the result of a fall in employment due to the minimum wage, as enterprises substitute capital for labour and adopt more capital-intensive production technologies.

While this remains a distinct possibility, particularly when the minimum wage is set too high, other research shows that productivity increases in enterprises were the result of organisational change, training and efficiency wage responses to increased labour costs from minimum wages.

Economy-wide labour productivity

At the aggregate level, minimum wages can result in more productive firms replacing least productive ones – and surviving firms becoming more efficient. These mechanisms can increase overall economy-wide productivity.   

In China, for example, it has been observed that higher city-level minimum wages resulted in lower survival probability of low-productive firms. There was no negative employment effect, however, because employment and productivity increased in surviving firms. Hence the minimum wage may have allowed more productive firms to replace the least productive firms, and forced incumbent firms to strengthen their competitiveness.

Learn more:
1 See Lüebker, M. 2011. “Labour Productivity”, in Sparreboom T. and A. Albee, eds, Towards Decent Work in sub-Saharan Africa: Monitoring MDG Employment Indicators, Geneva, ILO
2 Rodrik D. 2007. One Economics, Many Recipes: Globalization, Institutions, and Economic Growth, Princeton University Press