Minimum Wage, Business Dynamism, and the Life Cycle of Firms

This paper studies the effects of the minimum wage on the life cycle of firms. We start by building a tractable model where heterogeneous firms have labor market power, invest in innovation, and choose formal or informal sectors. The model predicts that a minimum wage hike not only shrinks the young and lower-productivity firms but also decreases the incentives to innovate, resulting in slower life-cycle growth. We show that these predictions hold in Brazilian administrative and census data, leveraging the variation in exposure to the minimum wage between 1999 and 2010. An increase in the minimum wage (i) decreases the growth rates of small and young establishments and (ii) increases the growth rates of old and large establishments. At the municipal level, we observe an increase in informal employment and in the earnings of both formal and informal workers. Lastly, we augment our simple model into a full quantitative general equilibrium model with monopsonistic firms, endogenous innovation, and formal-informal choice, calibrated to the Brazilian economy. A counterfactual minimum wage increase generates reallocation from young to old firms, dampens innovation at low-productivity firms, and expands the informal sector. Our findings suggest that the minimum wage is a possible explanation for the decline in the importance of young establishments and business dynamism in Brazil.