Tread carefully on minimum wage reform

Setting a wage floor fails without other reforms and adequate enforcement 

Milton Friedman famously called minimum wage laws a form of discrimination against low-skilled workers. Serious doubts have been cast on that tenet of neoclassical economics over the past few decades, so much so that the economic and ethical benefits of such legislation can fairly be held to outweigh its downsides.

With the labour ministry having moved a cabinet note seeking to merge four wage-related laws and set a mandatory national minimum wage—part of a thrust to refurbish and consolidate 44 labour laws into four or five broad labour codes—the National Democratic Alliance government is looking to reap these benefits.

But as with all such propositions, it should bear in mind that conditions apply.

The traditional case against wage floors is succinct: It is distortionary pricing that reduces demand for workers affected by the wages since employers operate with the rationale of economic efficiency.

David Card and Alan Krueger of America’s National Bureau of Economic Research presented research in 1993 that suggested otherwise and caused widespread rethinking of this erstwhile truism.

A substantial volume of new research followed, showing that modest minimum wage hikes caused no discernible change in employment levels.

Pushback from economists such as David Neumark and William Wascher notwithstanding, the new position has proved resilient.

Yet, the Indian instance is a prime example of why this may not always hold true. With the informal economy accounting for 90% of the workforce and 50% of the national product, employers hold disproportionate bargaining power.

The resulting wage levels leave enough wiggle room for them to absorb the costs of corrective legislation.

Any minimum wage legislation also runs the risk of being mere tokenism. In the decades since the Minimum Wages Act of 1948, the government has shown a distinct lack of ability to enforce it across the vast informal sector.

This inability to enforce existing social security provisions, inadequate as they are, across swathes of the formally employed labour force is a corollary of this. Despite the establishment of a framework for the formulation of social security schemes via the Unorganised Workers’ Social Security Act of 2008, there has been little progress.

Finally, most empirical studies concerning the impact of minimum wages on poverty in developing countries show different effects at various points of the wage distribution curve.

While aggregate poverty levels may decrease, there is a possibility that some low-income households will be pushed into poverty. In the absence of a safety net, they run the risk of being permanently relegated to an economic underclass.

If the government wants to still go ahead, it should set an optimal minimum wage rate—a modest hike followed by periodic inflation-linked revisions—in relation to the median national income and update anachronistic labour laws to make it easier for employers to adjust their workforce in accordance with market conditions.

Yet, there is little transparency so far on how the government means to arrive at the minimum wage.

Weak demand and uncertain macroeconomic conditions coupled with the need to factor in substantial economic diversity across states mean it will be a delicate balance to achieve.

As for updating labour laws, it has a long tradition of being politically verboten.

Come the budget session in February, the government will push for easing some restrictions here as part of the proposed industrial relations code.

Given its current lack of political capital, the opposition’s obstructionism and the emotive nature of the issue, the prognosis doesn’t seem positive.

Minimum wage reform is simply one measure in an interlocking system necessary for poverty alleviation.

When implemented in isolation, or when guided by political considerations instead of economic, it runs the risk of being ineffective at best and counterproductive at worst.

The government must bear this in mind in the coming year where it hopes to double down on economic reforms.

Is the proposed minimum wage reform likely to be successful?