If the purpose of minimum wage is to improve the lot of the poor, then it should be compared to other similar programmes, such as direct cash transfers
Whenever economists argue that the proposed increase in minimum wage in India will retard employment growth for low-skilled and informal workers, they are accused by sceptics of trotting out a tired old textbook model that ignores many real-word complications and, therefore, has no relevance to the real world. The textbook model is the idea that if labour is mandated to be more expensive, many employers will find ways to make do with fewer workers.
The sceptics say that the model ignores the possibility that a higher minimum wage would boost firm efficiency as well as the total demand for goods and services, rendering moot any disincentive for hiring brought about by higher labour costs. They cite a few studies have found that increase in minimum wage had little or no effect on employment and go on to argue that higher minimum wage is a particularly effective tool to foster economic growth and inclusion. We, however, find their claims unconvincing.
Because there are so many other forces acting simultaneously on the employment levels, isolating the effect of minimum wage is complicated. Depending on their data and the statistical techniques, researchers have found a wide range of estimates of the effect, and they continue to debate which statistical techniques are the most appropriate.
Until the empirical researchers resolve the debate, the rest of us must use the model about the effects of the minimum wage that is the most plausible. The model that a higher minimum wage discourages hiring is highly plausible (it is the law of demand, after all).
Against it, the sceptics raise the possibility that a firm offering the so-called efficiency wage—a wage rate that is higher than the market rate—would become a more attractive employer relative to others. Its workers would consequently work harder and quit less often, boosting firm efficiency. The sceptics assume that the efficiency gains would be large enough to overwhelm the higher minimum wage’s effect on the firm’s bottom line.
Even if the efficiency wage model were sound, it would have little to say about minimum wage. A national minimum wage does not increase the relative attractiveness of any individual employer paying the minimum wage, because it raises the wages paid by all such employers.
The sceptics may raise the possibility that in India the source of the efficiency gains may lie in enabling the poorest workers to buy better food and healthcare. However, if firms could boost efficiency by paying a higher wage, why do they need to be mandated? Are we to believe that firms are leaving such straightforward profit-enhancing opportunities unexploited?
It goes against what we know about firm behaviour, not to mention poor people’s circumstances. Abhijit Banerjee and Esther Duflo have shown that when poor people earn a little bit more, they spend very little of the extra income on productivity-enhancing investments in nutrition or health, because they lack knowledge and a surrounding environment that makes it easy to make good choices. Minimum wage does little to alter their circumstances.
If minimum wage’s purpose is to improve the lot of the poor, then it should be compared to other similar programmes, such as direct cash transfers. Is it not plausible to suspect that the coverage of minimum wage is more limited, its enforcement costs higher, and its disincentive effect on hiring more pronounced?
We are not arguing against redistribution, only that the minimum wage makes for a poor redistributive tool.
The sceptics additionally raise the possibility that a higher minimum wage would boost the overall demand for goods and services (what economists call “aggregate demand") and thus spur more hiring. However, lack of aggregate demand is not usually what is holding back employment growth in India. India’s aggregate demand usually runs ahead of the economy’s supply capacity, which is why we have inflation. Even in those rare cases (such as recessions), when aggregate demand is the constraining factor, a higher minimum wage would not help. Because minimum wage is a redistributive programme, it would redistribute demand, not increase it.
Strangely, the sceptics hail the possibility that a higher minimum wage will result in increased incentive for firms to invest in technology. However, the technology for which there would be an increased incentive would be that of the labour-saving kind. There would be more robots and less assembly-line workers. Low-skilled workers all over the world are already facing the prospect of being made economically redundant by automation. For a country of almost a billion such workers, to accelerate the process with a well-intentioned but misguided increase in the minimum wage would be a cruel irony.
Nimish Adhia and Archit Puri are, respectively, an associate professor of economics at Manhattanville College in New York, and a senior associate at the Centre for Civil Society in New Delhi.