Introduction

Policies intended to uplift can sometimes end up harming the very individuals they aim to protect if they are misguided or not carefully thought out. Many envision an economy where every worker is guaranteed a fair income that provides security and stability for their daily needs,ensuring that hard work is always rewarded with enough to live comfortably. However,imagination alone can only take us so far. A modest version of this ideal can be found in the policy of minimum wage.

As defined by the International Labour Organization, the minimum wage is the minimum amount of remuneration that an employer is required to pay wage earners for the work performed during a given period, which cannot be reduced by collective agreement or an individual contract. It is calculated by the government based on factors such as the level of skill, the nature of work, and the cost of living, with the goal of preventing the exploitation of workers and increasing wages that are considered "too low."

While research on impact of minimum wages remains inconclusive in India due to low compliance in many regions, a study by the International Labour Organization found that a 1 percent increase in minimum wages leads to a 0.623% increase in employment in India. However, it is important to consider the nuanced evidence surrounding the effects of minimum wage, recognizing that these impacts can vary significantly across different segments of the workforce and economic contexts.

Nevertheless, it is worth noting that some economists, like Henry Hazlitt, cautioned against making the provision too ambitious, arguing that a minimum wage law is, at best, a limited solution to the problem of low wages. The potential benefits of such a law will only outweigh the possible drawbacks if its objectives are kept modest and we will see why.

Selective Social Welfare

Henry Hazlitt, drawing from the Austrian School of economics, argued that if employers are required to pay ₹500 per worker per day, those who are not valued at that rate by their employer simply won’t be hired. In attempting to raise their standard of living, we essentially deny these individuals the opportunity to earn according to their skills and circumstances, while also depriving the community of the services they could provide. While some workers will be helped by the higher wage, others will be forced out of employment altogether. In essence, low wages are replaced by unemployment, causing greater harm than good.

Indeed, raising minimum wages too much can deter employers from hiring low-skilled workers, especially in sectors like agriculture, textiles, and small manufacturing. Businesses with limited profits may respond by reducing staff, automating tasks, or shifting operations to regions with lower labor costs. This could result in even fewer job opportunities for some workers, particularly those in informal industries, potentially deepening poverty.

In India’s unorganized sector, ensuring compliance with minimum wage laws is challenging due to inadequate monitoring. However, in a country where only 10% of the workforce is employed in organized sectors, enforcing such measures could lead to severe consequences.

Price Pressures

An industry that is forced to pay higher wages might shift the burden to the consumers, inducing a hike in the prices of their goods and services. For instance, sectors like construction, hospitality, and retail might face rising production costs, potentially creating inflationary pressures.

David Card and Alan Krueger, recipients of the 2021 Nobel Prize in Economic Sciences for their research on minimum wage and employment, explored the impact of minimum wage increases in their study titled “Minimum Wages and Employment: A Case Study of the Fast-Food Industry in New Jersey and Pennsylvania.” Their analysis focused on the fast-food industry in Philadelphia, a city spanning both states. In April 1992, New Jersey raised its minimum wage from $4.25 to $5.05 per hour, while Pennsylvania’s minimum wage remained unchanged during the same period.

The study found that fast-food prices in New Jersey rose relative to Pennsylvania, indicating that much of the cost of the minimum wage increase was passed on to consumers. Additionally, the researchers noted that there was no evidence to suggest the wage hike in New Jersey led to reduced employment in the state’s fast-food restaurants. And that’s what we saw.

What we didn’t see was that the higher fast-food prices likely forced individuals to reduce their spending on other goods and services. This, in turn, may have led to decreased revenues in other industries, which struggled to maintain or lower their prices. As a result, these industries invested less in productivity improvements and were compelled to hire fewer workers or even lay off existing staff.

The Smaller the Hustle, the Bigger the Hurt

Passing higher costs onto consumers isn’t always feasible, as increased prices can drive customers toward alternatives or lead to decreased demand for the product. On the flip side, keeping prices steady could force small producers out of business, leading to reduced output and unemployment through another route.

Minimum wage laws can further complicate matters for Micro, Small, and Medium Enterprises (MSMEs), which are essential to India’s economy and job market. Faced with rising labor costs, these businesses often find it difficult to adapt, especially in competitive markets with little room to adjust prices. This pressure may compel some MSMEs to scale back hiring or hike prices, ultimately risking their market position. Again, due to non-compliance, limited regulation and monitoring in certain unorganized sectors in the country, accurately assessing the level of impact remains challenging.

However, in a paper by David Neumark and William Wascher titled “Minimum Wages and Employment: A Review of Evidence From the New Minimum Wage Research”, it was revealed that a 10% increase in the minimum wage reduces teenage employment by approximately 1-3% in the US, and many economists concede this result. So things are not as rosy as the headlines would have us believe.

No-Work Merry-Go-Round

Not only do consumers lose access to the products of industries driven out of business by higher costs, but a wage floor (minimum wage) also displaces workers previously employed in those industries. While wages in these industries may have been low, workers likely remained because better alternatives were unavailable. Job losses will compel displaced employees to seek work in sectors they initially found less appealing, effectively forcing them to settle for less. This increased competition for jobs in these alternative sectors may further drive down wages in those areas.

George Stigler, who received the Nobel Prize for his research on minimum wage, wrote in his article “The Economics of Minimum Wage Legislation” that the likelihood of less efficient workers being let go increases when their productivity falls significantly below the legal minimum wage, when demand for the product is highly responsive to prices, or when employers can easily replace them with other resources or more efficient workers. These displaced workers are likely to end up jobless or in unregulated jobs where they earn even lower wages. A minimum wage law, which prohibits employers from paying less than a set amount, effectively means that workers cannot secure employment in the regulated sector unless they find employers willing to hire them at that wage. This restriction can be interpreted as a fundamental violation of the basic human right to work, defined as the right to engage in meaningful employment without being hindered from doing so.

Some Proposed Remedies

All this might lead one to feel that addressing low wages and poverty is a daunting challenge, but it doesn’t have to be. Minimum wage laws aim, in part, to reduce employer control over wages and protect vulnerable groups from exploitation. However, a more effective approach could involve tackling labor immobility—the challenges workers face in transitioning between jobs, industries, or locations to find suitable employment.

Labor immobility could be significantly alleviated through public initiatives that provide comprehensive information about employment opportunities across different regions and industries. Additionally, retraining programs offering vocational training and financial support, such as loans to cover transitioning and relocation expenses, would further reduce barriers to mobility. While implementing such measures may be challenging when workers are hesitant or resistant to pursuing new opportunities due to personal inhibitions, programs aimed at boosting their self-esteem could significantly help overcome these barriers and encourage adaptability.

The most effective way to increase wages, Hazlitt argues in his book “Economics in One Lesson”, is by improving labor productivity. This can be achieved through various means: investing in capital and machinery, fostering innovation and enhancing managerial efficiency along with effective education and training programs. Higher productivity not only enriches the entire community but also raises the value of workers to employers, leading to higher wages. Ultimately, real wage growth stems from increased production, not government mandates.

To combat poverty, there is great appeal in the policy of Negative Income Tax(NIT). A negative income tax is a system designed to ensure that everyone receives a minimum guaranteed income. Under this model, individuals with low incomes receive financial support from the government, effectively resulting in "negative taxes" where they are paid more than they earn. As their income increases, the amount of financial support gradually decreases, until they reach a level where they begin contributing to the tax system instead. Milton Friedman proposed replacing the majority of existing welfare programs with a unified NIT system.

It may be argued that such a provision could act as a disincentive to work but an experiment led by Heather Ross, a PhD student in economics at MIT, in urban areas of New Jersey, Pennsylvania, and a few other regions, found that while the negative income tax (NIT) slightly reduced labor supply, the overall conclusion was that the income maintenance program had minimal impact on the likelihood of people, especially primary earners in families, to work.

A minimum wage is meaningful when a group of workers is being paid less than their true market value. Such situations typically arise in specific circumstances or regions where competitive market forces are weak or ineffective. However, these issues are often better addressed through unionization and effective oversight by the relevant authorities, which is currently lacking, rather than through wage mandates. This approach offers greater efficiency, flexibility, and fewer negative side effects

Conclusion

All in all, while there is no consensus regarding the overall effects of minimum wage increases on low-wage employment, a sizable majority of studies indicate negative employment effects. Issues such as increased unemployment among low-skilled workers, the loss of products for consumers, and challenges for small producers and MSMEs are problems that cannot be overlooked.

Although the minimum wage law has its appeal and, through effective regulation and monitoring by the government, can empower deserving workers who would otherwise be exploited, it is limited in its ability to address low wages effectively. To tackle inequality in the labor market, increasing labor mobility is essential. It is crucial to explore more efficient alternatives that do not carry the negative consequences of a minimum wage. As we've discussed, enhancing labor productivity through investments in technology, implementing effective training programs, running campaigns to boost workers' self-esteem, improving access to job market information, reducing exploitation, and refining the tax system to better address citizens' needs can all contribute to greater equity.

Negative Income Taxes can provide a guaranteed minimum income, and reduce the urgency for low-income individuals to accept poorly paid jobs, potentially leading to upward pressure on wages as employers compete to attract workers. But while NITs can enhance income security and reduce poverty, their effect on wages depends on how they influence workers’ willingness to work and how employers respond to these changes.

This is not to suggest that implementing these plans will be without challenges. However, unlike a wage mandate, these alternatives do not favor certain groups at the expense of others—at least not to the same extent if carefully exercised. That said, more conclusive evidence is needed on the impact of minimum wages in the job market to thoroughly understand and analyze the challenges they pose, as well as to design policies that effectively balance worker welfare with economic sustainability.

Finally, as citizens, it is crucial to look beyond the allure of such well-intentioned laws, which, as Henry Hazlitt put it, are merely a 

“Dead Sea fruit that turns to dust and ashes in the mouth.”

.    .    .

References:

1. Hazlitt, Henry. (1946). Economics in One Lesson: Minimum Wage Laws.
2. Neumark, David. Wascher, William. Minimum Wages and Employment: A Review of Evidence From the New Minimum Wage Research.
3. Card, David. Krueger, Alan. Minimum Wages and Employment: A Case Study of the Fast-Food Industry in New Jersey and Pennsylvania.
4. Stigler, George. The Economics of Minimum Wage Legislation.
5. Banerjee, Abhijit. Duflo, Esther. Good Economics for Hard Times.