Trade and Economy

Let the Minimum be Minimum!

The anatomy of minimum wages in Pakistan and its effects on the work force
In Pakistan, minimum wages for workers are fixed under the Unskilled Workers Ordinance 1969. The latest budget has increased the minimum wage rate from Rs.10,000 per month to Rs.12,000 per month, i.e., a twenty per cent rise. The budget document states that the purpose of this change is to raise the welfare of the labour class and in line with the increase in pay of government employees. In this article, I will examine whether this raise in any way benefits the economy in general and labour classes in particular?

A minimum wage is the lowest monthly remuneration that employers may legally pay to the workers. Equivalently, it is the lowest wage at which workers may sell their labour. Indicators that are normally used to set a minimum wage rate are the ones that minimize the loss of jobs while maintaining international competitiveness of domestic industries. Among the indicators are general economic conditions in the country as measured by the GDP, inflation, labour supply and demand situation, wage levels and wage differentials, growth in productivity, cost of doing business, living standards, and the prevailing average wage rate in the country.

Proponents of the minimum wage say it increases incentives to take jobs, as opposed to other methods of transferring income to the poor that are not tied to employment; increases the standard of living of the poorest workers; stimulates consumption, by putting more money in the hands of low-income people who spend their entire paycheques and hence increases circulation of money in the economy; removes low paying jobs, forcing workers to train for, and move to, higher paying jobs; reduces poverty and income inequality; boosts morale and forces' businesses to be more economically efficient.

In contrast, opponents of the minimum wage say it increases poverty; reduces quantity demand of workers, either through a reduction in the number of hours worked by individuals, or through a reduction in the number of jobs thus increases unemployment (particularly among low productivity workers); discourages further education among the poor by enticing people to enter the job market; slows growth in the creation of low-skilled jobs; results in jobs moving to informal sector which allow employment without minimum wage law; causes rise in inflation as businesses try to compensate by raising the prices of the goods being sold and hurts small business more than large business. Although minimum wage laws are in effect in many jurisdictions, differences of opinion exist about the benefits and drawbacks of a minimum wage. In this context, let us see the potential effects of minimum wage on the well-being of workers.

Evidence suggests that the most important channels of adjustment are: reductions in labour turnover, improvements in organizational efficiency, reductions in wages of higher earners, and small price increases. Given the relatively small cost to employers of modest increases in the minimum wage, these adjustment mechanisms appear to be more than sufficient to avoid employment losses, even for employers with a large share of low-wage workers.

Reduction in Employment: The employment effect of the minimum wage is one of the most studied topics in economics. Most studies find that the minimum wage has no visible impact on the employment prospects of low-wage workers. This is because the cost rise due to the minimum wage is small relative to the overall cost of production and low relative to the wages paid to low-wage workers.

Reductions in non-Wage Benefits: Employers might respond to a minimum-wage increase by lowering the value of non-wage (fringe) benefits, such as health insurance and pension contributions. The empirical evidence, however, points to small or no effects along these lines. Reductions in Training: Employers might reduce their expenditures for on-the-job training for low-wage employees. Empirical evidences are not conclusive: some studies find negative effects of minimum wages on training, while others find little proof of an effect in either direction. Changes in Employment Composition: Firms may adjust to a higher minimum-wage by upgrading the skill level of their workforce, rather than cutting the level of their staffing. This process could possibly work against the employment prospects of unskilled workers.

Improvements in Efficiency: Firms might respond to a minimum-wage increase with efforts to improve operational efficiency including "tighter human resource practices, increased performance standards and work effort, and enhanced customer services.” Employers might prefer these kinds of adjustments to cutting employment because employer actions that reduce employment can "hurt morale and engender retaliation." Efficiency Wage Response of Workers: A higher minimum wage may motivate workers to work harder, independently of any actions by firms to increase productivity. Higher wage increases the cost to workers of losing their job, motivating greater effort from workers to reduce their chances of being fired. Thus, workers may see higher wages as a reward from employers, leading workers to reciprocate by working harder. Any of these channels might be sufficient to eliminate the need for employment cuts.

Wage Compression: Employers facing higher wage costs for their low-wage workers may seek to compensate these costs by cutting the earnings of higher-wage workers. Sometimes firms delay or limit pay raises and bonuses for more skilled workers. Thus, minimum-wage compresses the overall wage distribution.

Reduction in Profits: Employers may also absorb the extra costs associated with a minimum-wage increase by accepting lower profits, along with those of their competitors, while some may reorganize the work process to reduce their costs of production. Minimum Wage as an Economic Stimulus: In a recessionary situation, a minimum-wage increase may increase demand for firms' goods, offsetting increase in wage costs. Since the minimum-wage transfers income from employers (high savers) to low-wage workers (low savers), it could spur consumer spending, which could potentially compensate firms for the direct increase in wage costs.

Inflation: Some employers may raise prices of their products, particularly if their competitors are experiencing similar cost increases in response to the minimum wage. Increase in inflation ultimately offset the benefit of rise in minimum-wage level. In sum, employers and workers at the same establishment may follow more than one of the above adjustment paths at the same time. Some of these adjustment paths reduce the benefit of the minimum wage to affected workers (reductions in non-wage benefits or training), but most have an ambiguous effect (reductions in hours of work or increased work effort) or no effect (lower profits or wage compression within a firm) on the well-being of low-wage workers. And some adjustment channels arguably improve workers' well-being (lower turnover or increased consumer demand). All in all, the global experience shows that minimum-wage increase does not have a discernable effect on the well-being of low wage workers.

In Pakistan, enforcement of the minimum wage legislation has always remained lax in protecting the living standards of workers because the minimum-wage increase failed to neutralize the impact of inflation. Implementation has been lax because of weak governance. Moreover, majority of wage earners in agriculture and informal sectors do not benefit from minimum wage fixation. There is thus a need to raise minimum-wage by fully indexing it with inflation and for effective implementation of the minimum-wage law while covering all sectors of the economy.

The writer is a Professor of Economics at School of Social Sciences and Humanities at NUST, Islamabad. [email protected]

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