Why India’s minimum wage policy may backfire
While higher minimum wages may not reduce overall employment, they can make it difficult for less productive workers to find jobs
Mumbai: The recent clash between the Delhi high court and the state government over the quashing of the government’s notification on minimum wages has reignited the debate on minimum wages in India. Neoclassical economists have long warned against setting a wage floor, arguing that a government regulated price for labour can distort labour markets and have the unintended effect of reducing employment. This consensus has now begun to crack, with a number of empirical studies suggesting that an increase in minimum wages may not actually reduce jobs.
Research by Arindrajit Dube, an economist of Indian origin, has helped strengthen the case for a minimum wage at a time when concerns about inequality in incomes have risen globally.
A recent research paper by the economist John J. Horton of New York University sheds new light on this debate. Horton designs a novel minimum wage experiment in an online job market and finds that a higher minimum wage raised the wages of hired workers substantially but had a small impact on overall hiring, even as there were large reductions in hours worked. The minimal impact on employment, despite a substantial increase in cost of labour, can be explained by a “labour-labour substitution” effect.
At a higher minimum wage, firms are careful to hire more productive workers who then take less time to complete projects. According to the study, about half of the decline in hours worked can be explained by substitution towards higher productivity workers. This shift in employer preferences towards relatively more productive workers could adversely affect job prospects of less productive workers and may be counterproductive for a minimum wage policy.
According to Horton’s research, minimum wages in conventional markets could result in substantial substitution, leaving headcounts unchanged, but changing the kind of workers employed.
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