By Sadaf Hussain

Minimum Wage: Is this really a policy that benefits the poor? Or are there unintended consequences, something unseen that this policy is causing?

I was 14 when I first came across this concept, and saw the negative impact of minimum wage. While walking home from school, I witnessed a labour union screaming at the top of their voices, showing their anger against the company my father used to work for and against my father as well. The core issue was that the union wanted an arbitrary minimum wage. This clash went for almost a week, people coming out in front of my house, protesting against the management. After much deliberation, the management decided to talk to labour union to agree on a middle ground, but, unable to reach an agreement, the only solution was that the company had to shut down, and both, the labourers and the management, lost their jobs.

So who won and who lost this battle, when we forcefully set minimum wages? People say minimum wage is beneficial for the poorest of the poor but this isn’t really true. There are unseen, unintended consequences. I am here going to discuss myths that we have about minimum wage.

Myth 1: Minimum wage does not increase the costs of goods and services

Contrary to common perception, paying workers more might lead them to feel better but it adds extra burden on the producer. Who else is going to cover this cost but the consumer? Let’s assume that initially Employee A was producing goods worth Rs 100 per hour and was getting paid `80 per hour at market wages. Employer was happy earning, owner was happy with making Rs 20 profit. But now Employee A get Rs 120 because of the government has set the Minimum Wage at Rs 120. Employer won’t be paying Employee A from his pocket, he will transfer this additional cost to consumers by increasing the price of the good. This will cause a typical consumer to either switch to some other alternative or pay more for the same products, which will leave less money in consumer’s pocket, thereby reducing the consumer’s purchasing power.

Myth 2: Minimum wage reduce unemployment 

If a firm is unregulated (free to pay the employee whatever is mutually agreed upon), then, as in the above example, they are paying the employee Rs 80 per hour. If the employee is producing more than this price, he will get a raise automatically, or if not, a competing firm in the same industry might offer higher wages.

The current minimum wage policy does not even lift the family out of poverty | Photo Courtesy : Visualhunt

The current minimum wage policy does not lift the family out of poverty but increase unemployment | Photo Courtesy : Visualhunt

If there is a regulated market, on the other hand, where employers have to pay according to government norms and regulations, this will make it harder for the people to get employed. The value of goods/services they produce might be less than the amount that employers have to pay them. A smart decision on the part of the employer would then be to have a stricter hiring policy, and not to hire under-skilled or untrained employees. They may also hire one person with more skills to do a composite job role or install a new machine to reduce the cost, which may earlier have been split between that individual and a less qualified employee.

mimimum wage

Figure: Effect of instituting minimum wage explained in a chart

Image Courtesy:

Basic economics tells us that as the price of a good or service rises, demand for that good falls—labour is no exception. In the above graph, where Y-axis depicts price of workers and X-axis, quantity demanded, as price rises from Pe (the equilibrium price agreed upon by labourers and the management) to Pmin (the government-determined minimum wage), quantity demanded of labourers falls from Qe to Qd. Government interference therefore results in more unemployment.

To conclude, Minimum wage policy hurts the very people whom it intends to benefit. It puts jobs out of reach for those who may otherwise be hired at a market wage lower than the minimum wage. I know a guy who earns less than the stipulated minimum wage but he is happy because at least he is earning, and not living under a bridge and asking for alms. Employers, consumers and eventually, the economy as a whole is negatively impacted by forcing minimum wage regulations on companies—so who wins?

This article was first published on Spontaneous Order.

Posted by The Indian Economist