The impact of minimum wage policies in financially distressed firms

September 19, 2020

The Portuguese government promised to increase the minimum wage to 750 euros by 2023. If this goal is achieved, between 2014 and 2023 the nominal minimum wage will have increased 55%. The final objective of this measure is to reduce poverty and income inequality. However, it implies additional costs to firms and customers. When many firms are already under pressure and living in a context of high uncertainty due to the covid-19 pandemic, the announced minimum wage increases cast further doubts on the evolution of employment and on the financial condition of firms.

The analysis sheds light on the effects of minimum wage increases on the employment, profitability, and survival of firms. The main variable of analysis is the additional cost arising from future minimum wage increases, given the present employee structure of the firm. The estimates suggest that minimum wage increases since 2014 in Portugal reduced employment growth and profitability, and increased firm exit, in particular for financially distressed firms.

According to these results, minimum wage policies may have had a supply side effect by accelerating the exit of low profitability and low productivity firms and, thus, contributing to improve aggregate productivity through a cleansing effect. Overall, whether or not these policies contributed themselves to the growth of the economy is debatable.

Importantly, the analysis in the paper refers to a period of economic expansion and demand growth, which may have allowed firms to mitigate the impact of minimum wage increases through increased activity. In the current context - of a recession, rapid unemployment growth and heightened uncertainty - the cleansing effect might become a case of throwing the baby away with the bathwater. In other words, firms that would be profitable in normal times, may go bankrupt, causing the destruction of employment and the loss of accumulated social capital.

Click here to go to the paper by Fernando Alexandre, Pedro Bação, João Cerejeira, Hélder Costa, and Miguel Portela.