Misleading article in Mint on effects of minimum wage law
They cite George Stigler’s work on minimum wage saying that minimum wage doesn’t reduce poverty and instead increases unemployment. They also cite a study in the US that found a decrease in employment due to minimum wage. They further argue that minimum wage will speed up automation in Indian manufacturing. They question the implementation feasibility of the act
All these are genuine concerns but this is a misleading picture of minimum wage literature. To start with, let’s consider the authors’ summary of Stigler’s argument “minimum wage does not satisfy its original intentions — elimination of poverty — and will tend to increase unemployment and reduce family income.” This isn’t a complete summary of Stigler’s argument.
While Stigler did say that minimum wage doesn’t reduce poverty and can increase unemployment, he also added that minimum wage can increase productivity because well-paid workers are motivated to work better. This is partly because of increased motivation and partly because it is costly to lose the job now. Also, remember that this seminal work of Stigler was way back in 1946. Much has happened since then.
Apart from this, there are other famous theoretical papers on minimum wages. One by Stiglitz, Kaushik Basu and Genicot, where they argue that people are financially insecure at lower income levels and hence they are willing to supply “more labour”. They argue that providing “wage floors” reduces their risk. Other papers argue that people face uncertainty risks during a job transition. Hence, it tilts the balance in favour of employers, making them pay only retention wage.
Thus, increased productivity, need to address labour market frictions are two other important arguments in favour of minimum wage law. The Mint article should have ideally mentioned these too if it were an objective analysis.
Let’s come from theory to empirics because minimum wage law has always been a puzzle because it defies many textbook effects. For instance, the most famous prediction is that minimum wage law increases the cost of business, forcing them to close down. But this didn’t happen in many cases.
David Card’s famous 1993 paper analysed the effect of minimum wages on fast food restaurants and find no effects of unemployment. A host of other studies that followed also found similar results of minimum wage laws. Several economists had also written a letter to Obama a few years back to increase the minimum wage. Paul Krugman neatly summarised the broad trend of the findings — for the level at which the wages are currently, there is no compelling evidence to say that minimum wage laws cause unemployment.
The overwhelming evidence contrary to textbook economics is because there are labour market frictions that markets don’t address. Minimum wage law corrects those. The Mint article doesn’t mention this broad trend of results from numerous studies, instead, picks a one off study which shows the opposite result.
A fair question now may be — will the minimum wage laws have a different effect in the US and in India? Again, one can always quote studies that suit one’s argument but many such studies tend to be simulations, projections, estimates and are not rigorous enough.
The best evidence of minimum wage laws comes from this large RCT on NREGA by Muralidharan et al, with a large sample size. Literally, the whole of erst-while united Andhra Pradesh was part of this sample. So, the results are generalizable. Also, this RCT captures the General Equilibrium effects, meaning that it captures effects such as employment in one village leading to unemployment in others, instead of focusing on only a narrow area.
The key argument is that NREGA provides a “wage floor” to workers, similar to Basu, Stiglitz and Genicot’s paper discussed above. It means that NREGA provided a bargaining tool for workers. They can choose not to work for wages below NREGA, thereby pushing up their wages. This is similar to the effect of minimum wage laws.
It was initially argued that such bargaining phenomenon can occur only during the NREGA season thereby downplaying its ability to increase wages of other jobs in other seasons. On the other hand, some argued that NREGA does increase wages of labour in other sectors but it led to unemployment, similar to minimum wage law effects.
Muralidharan’s paper finds that NREGA resulted in the best of both worlds. It both increased the wages in other sectors, even during the non-NREGA season, and also did not cause unemployment. This demonstrates the existence of labour market frictions. Shamika Ravi also admits that NREGA corrected the labour market wages, reducing the frictions and inefficiencies. This is quite contrary to the textbook economics and also against the key argument of the Mint article.
This doesn’t mean that minimum wage law can never cause unemployment. The level of wage is obviously important. If the minimum wage is fixed at Rs.50,000 per month for an unskilled job, it will definitely cost distortions. But, wages are generally not at those levels to cause distortions at the commonly envisaged levels. The sector also matters.
An objective analysis of minimum wage law should also outlay both the theoretical arguments in support of minimum wage law — increased productivity, higher wages, ability to correct market frictions — and also a general trend of insights from empirical studies’ that find no impact of such laws on unemployment. I find the Mint’s article misleading because it doesn’t touch these aspects.