Powerful new research sends a flashing red warning to the 19 states that increased their minimum wage on Jan. 1 this year. Those increases are coming with a hefty side of unintended consequences: Small business suffer as big corporations get bigger. Slowly, the new regulations strangle innovation and cut long-term growth.
Minimum wages have been studied for decades to better understand their impact on businesses, employees, and job seekers. Less understood are the direct impacts on business formations and employment shifts between firms. That has changed thanks to a new paper by two economists, Nirupama Rao and Max Risch. Their work uses a large sample of anonymized U.S. tax returns from 2010-2019 that includes not only individual filings (which speaks to whether or not people had jobs), but also business filings that speak to revenues, costs, net earnings, and market entry and exit. Spare a moment of appreciation for Rao and Risch: Compiling and analyzing all this data, all while respecting the (rightfully) extremely strenuous data security requirements for IRS data, was a Herculean effort.
To start, the firm return data shows small net job losses, which are partially but not completely accounted for by reduced employee turnover. But that’s not where the truly bad news is. Instead, it is the business dynamics data that make their work one of the most negative minimum wage papers yet published.
Quick detour: The most recent Nobel Prize in Economics went to a trio of economists whose work centers on “Creative Destruction.” Creative destruction is the core of economic growth: Entrepreneurs with new ideas create better firms that replace the old. This drives productivity, helping humanity do more and prosper. In case it wasn’t clear from the Nobel Prize, creative destruction is one of the most important phenomena in economics.
Back to the new research and why it is such a gloomy indicator for minimum wage increases: The IRS business data shows a deterioration of creative destruction. It turns out that after a minimum wage increase, the number of businesses in an affected geography immediately starts to drop. Now, this might not be terrible news if the reduction was driven by a slight acceleration in the closure of older, underperforming companies. But existing businesses are fine. In fact, corporations—generally the largest, most entrenched companies—gain size and market share.
Instead, the loss comes entirely from a decline in new businesses. Each year post-increase, fewer and fewer entrepreneurs take the leap and enter the market. By the fourth and final year in the dataset, there is a 5.5% reduction in the frequency of new businesses. And, given this trend, it is probably safe to assume the erosion gets worse than observed in the final year of data.
Putting up such a significant barrier to entry for new businesses is one of the worst things you can do to an economy. You are choking off that vitally important creative destruction dynamic right at the source.
In a future with fewer and fewer businesses and more and more jobs concentrated at the big corporations, the economy suffers. Small business owners suffer from a lack of market entry points. Entrepreneurs struggle to turn an idea and sweat into a successful business. Workers suffer from lack of employment options. Consumers suffer from reduced diversity in places to shop, to eat, to get services. And in a less dynamic, less diversified economy, incomes flatten and growth declines.
Cheers to two researchers whose enormous effort has boosted our knowledge base of minimum wage. Unfortunately, their results show significant negative consequences. Small businesses decline as big corporations get even bigger. Slowly, the increases strangle innovation, the lifeblood of a successful economy.
