Given the dominance of the informal sector and small businesses in India, the consequences would be largely negative
One of the enduring policy debates across rich and poor countries is whether or not the government should specify a minimum wage. And if so, how high should it be? This debate was front and centre recently when the Delhi High Court quashed the Delhi government’s attempt to increase the minimum wage.
Although the minimum wage and its effect on employees and employment is fundamentally an economic question, the debates are usually dominated by views formed by an individual’s political leanings rather than by hard economic evidence. While those on the left of the political spectrum argue that a higher minimum wage is an effective anti-poverty tool and will provide people a living wage, limit the number of hours they need to work to make ends meet and help fight growing inequality, those on the right of the political spectrum argue that a higher minimum wage will deter job creation and turn away businesses.
In this article, I attempt to infuse some hard evidence into this debate based on our study of more than one million hourly wage workers in the US.
The unique aspect of our study is that it is the first of its kind to use precise administrative wage data on one million hourly wage employees from over 300 firms spread across 23 different industries to estimate the effect of six large, isolated minimum wage increases on employment. Our data allow us to precisely estimate the employment dynamics of workers directly affected by minimum wage increases and also highlight the channels through which the effect manifests.
Our evidence can be easily summarized.
First, in response to a minimum wage hike, we find that firms do not fire existing minimum wage employees. Thus existing minimum-wage employees experience a wage hike and no adverse consequence. This higher wage in turn helps them to be current on their debt payments and also improves their access to outside finance. This is evidence in support of those on the left.
On the other hand, we find that following an increase in the minimum wage, firms slow down hiring of new low-wage employees. Specifically we find that low-wage hiring in firms decreases by about 5% following a 10% increase in the minimum wage. We find that the decline in low-wage employment occurs within the first quarter after a minimum wage increase. This is the negative effect of a minimum wage increase and this one goes to the right.
We also find that there is a difference in the response to a minimum wage hike across tradable and non-tradable sectors. Tradable sectors make goods and services that can be traded across distances. The typical example in India is a factory making plastic products. The non-tradable sector on the other hand includes establishments such as restaurants and hair salons, whose services cannot be traded. You have to get your hair cut only by hair salons in your neighbourhood.
We find that firms in the non-tradable sectors do not reduce the rate of hiring in response to an increase in the minimum wage. We conjecture this is because such establishments do not compete with firms outside their region and, hence, may find it easier to pass along the increase in the wage to their customers through a higher price for their product or service. On the other hand, we find that firms in the tradable sector are the ones that decrease employment in response to the minimum wage increase. As these firms have to compete with other firms that do not experience a minimum wage hike, they may find it difficult to increase prices.
To summarize, we have three pieces of evidence. Increases to the minimum wage:
•Do not affect the employment of existing low-wage employees.
•Reduce future hiring of low-wage employees.
•The reduction in hiring is concentrated in firms in the tradeable sector.
Although we do not conduct a full-fledged welfare analysis, these results can serve as a guide for cities and states contemplating a minimum wage hike. Our results indicate that a higher minimum wage will adversely affect employment, especially in areas with a large pool of new low-wage employees entering the workforce or if the employment is predominantly in the tradable sector. On the other hand, the net benefits of a higher minimum wage will be especially higher in areas where employment is dominated by the non-tradable sector.
Finally, a legitimate question to ask is how our study from the US applies to the Indian context. The one major difference between the setting we study and India is in the size and importance of the informal and small-business sectors. In India, the informal and small-business sectors employ the largest number of minimum wage employees. In comparison, our study focuses on medium to large firms from the formal sector in the US. This difference will affect the applicability of our results in two ways.
First, enforcing minimum wage laws is quite difficult among informal and small-business firms. These firms may find it easier to circumvent these laws and continue paying a low wage to their employees. To this extent, the effect of any change in minimum wage on employment may be muted.
Second, if the government were to somehow find a way to enforce the laws, a higher minimum wage would have a much more negative effect on employment in India than our estimates suggest. This is because small businesses have very limited market power. Their ability to pass on a higher wage bill to their customers through higher prices is limited. If they increase prices, customers will quickly change habits and shift to shopping elsewhere. This in turn will prompt these firms to either close down completely or shift to a place with a lower minimum wage. Thus, our estimates should be taken as a lower bound on the adverse employment effects of a higher minimum wage in India.
Radhakrishnan Gopalan is a professor of finance in Olin Business School, Washington University.