Minimum Wages and Rural and Urban Firm Entry and Exit

By Yulong Chen, Liyuan Ma, and Peter F. Orazem

The US federal government has not increased the minimum wage since 2009. However, since then, 29 states and the District of Columbia have increased their minimum wage above the federal level. Many studies analyze the effect of the minimum wage on employment with mixed results. To the extent a consensus exists, it is that the minimum wage likely has small negative effects on low-skill employment (Neumark and Shirley 2021). Because prevailing wages are lower in rural markets than in urban markets, rural workers and firms should face the largest positive or negative impacts from a commonly applied minimum wage. While Even and MacPherson (2019) did find that rural areas had a greater adverse effect from the minimum wage, Godoy and Rich (2020) and Winters (2020) find that the lowest wage or least populated areas had the least negative, or even positive, employment effects from minimum wage increases.

Less commonly studied is the effect of minimum wages on firm profitability. High minimum wages have to lower firm profitability, and the effect should be largest in low-wage industries such as retail, hospitality/restaurant, and entertainment. Past studies show that minimum wages lower profit for the most affected firms in a broad sample of industries (Draca et al. 2011) and lower rates of firm entry (Rohlin 2011; Draca et al. 2011; Luca and Luca 2017). We extend that analysis to compare firm entry and exit between urban and rural markets and find that the minimum wage significantly decreases establishment entry and increases the exit of incumbents. A 10% increase in real minimum wage reduces the urban establishment entry rate by 4.4% and raises the urban firm exit rate by 3.1%. When we convert these estimates into their market equivalents, the combined effect of a 10% increase in the minimum wage represents a 0.8% decrease in the number of urban firms. The effects in rural markets are of comparable size—a 6.9% decrease in the firm entry rate represents a 1.4% increase in the firm exit rate and a 0.8% decrease in the number of firms overall. When we focus on markets on either side of state borders to control for the strength of the local market, we find that the side of the border with the higher minimum wage experiences lower firm entry rates and higher firm exit rates compared to its neighbor across the border. A 10% increase in the border minimum wage lowers the number of urban firms by 0.6% and lowers the number of rural firms by 0.8%. We find similar effects in all sectors analyzed.

Where the minimum wage bites hardest

From a firm perspective, the cost incurred from a minimum wage policy depends on how much the mandated minimum raises labor costs. For firms that primarily hire salaried workers or those with more than a high school degree, the minimum wage would not have much of an effect. However, firms for whom a large fraction of workers are low skill and paid hourly, the minimum wage could have a substantial effect.

We illustrate this in table 1, which shows the distribution of wages in metropolitan and nonmetropolitan markets and for representative low-skill occupations. At the median, metropolitan wages are 20% higher than nonmetropolitan wages, meaning that a common minimum wage will affect a larger share of workers in less populated markets. As a result, a $15/hour minimum wage would raise wages for 31% of hourly workers in metropolitan markets and 42% of hourly workers in nonmetropolitan markets. The metro/nonmetro wage gap is around 10% in low-wage sectors, and the change would affect a much larger share of the workers. In retail, hospitality, and restaurants almost all rural workers would have wage increases and the percentage increase in rural firms’ wage bills would be greater than for urban or metro firms, which should translate into larger reductions in firm entry and larger increases in firm exits in the least populated areas of the United States.
 

Estimated effects on firm entry and exit

Our analysis examines how state minimum wages correct for inflation-affected firm entry and exit by county, while controlling for factors that affect the strength of the local market and the long-run average entry rate in the same county and industry. Table 2 shows a summary or our findings and presents estimates as the implied effect of a 1% minimum wage increase on the rate of firm entry and exit and on the overall number of firms. We present estimates separately for urban and rural markets for all firms, firms in select low-wage sectors, and firms in adjacent counties on either side of state borders. Unlike results for employment effects of the minimum wage, the findings are very consistent—higher minimum wages lower the number of firms opening and increase the number of exiting firms. As a result, the number of firms falls as the minimum wage rises. Focusing on the effects at state borders, the decrease in firm numbers is slightly larger in rural than in urban markets and is particularly pronounced in recreation and entertainment. The impacts on retail and hospitality are roughly comparable to the magnitude of the adverse effects on firm entry and exit across all sectors. It is interesting that the differences in adverse outcomes from the minimum wage do not differ more between urban and rural markets, given that prevailing wages are 20% higher in metro than in nonmetro areas. Returning to table 1, the answer appears to be that when we look at specific low-wage occupations, the urban-rural wage gap is much smaller than the gap in wages overall. Consequently, the bite that the minimum wage takes out of firm profitability is only slightly bigger in the rural than in the urban markets.
 

Note: The elasticity of net entry is relative to the incumbents.

Acknowledgements

We are grateful for partial research support under USDA-NIFA grant 2018-68006-27639 and a grant from the Charles Koch Foundation. The authors declare that they have no known competing financial interests or personal relationships that could have appeared to influence the work reported in this paper.

References

Draca, M., S. Machin, and J. Van Reenen. 2011. “Minimum Wages and Firm Profitability.” American Economic Journal: Applied Economics 3(1):129–151.

Even, W.E., and D.A. Macpherson. 2019. “Where Does the Minimum Wage Bite Hardest in California?” Journal of Labor Research 40(1):1–23.

Godoy, A., and M. Reich. 2020. “Are Minimum Wage Effects Greater in Low-Wage Areas?” Industrial Relations: A Journal of Economy and Society (forthcoming).

Luca, D.L., and M. Luca. 2017. “Survival of the Fittest: The Impact of the Minimum Wage on Firm Exit.” Harvard Business School Working Paper No. 17-088.

Neumark, D., and P. Shirley. 2021. “Myth or Measurement: What Does the New Minimum Wage Research Say about Minimum Wages and Job Loss in the United States?” National Bureau of Economic Research Working Paper No. w28388. doi: 10.3386/w28388.

Rohlin, S.M. 2011. “State Minimum Wages and Business Location: Evidence from a Refined Border Approach.” Journal of Urban Economics 69(1): 103-117.

US Bureau of Labor Statistics (BLS). 2019. “May 2019 National Occupational Employment and Wage Estimates United States.”

Winters, J.V. 2020. “Minimum Wages and Teen Employment across the Urban Hierarchy.” Mimeo.

Suggested citation:

Chen, Y., L. Ma, and P. Orazem. 2021. "Minimum Wages and Rural and Urban Firm Entry and Exit." Agricultural Policy Review, Winter 2021. Center for Agricultural and Rural Development, Iowa State University. Available at www.card.iastate.edu/ag_policy_review/article/?a=120.