What makes minimum wages work

Representative image

Earlier this month the Union cabinet approved the Wage Code Bill, which seeks to subsume existing laws related to workers remuneration and enable the government to fix a ‘minimum wage’ for workers. Even as the level of the minimum wage is debated, the benefits of the policy itself, particularly its effect on job creation, are also being fiercely contested.

A new paper authored by Vidhya Soundararajan of Indian Institute of Management, Bangalore suggests that, ultimately, a minimum wage policy might be only as effective as the level of enforcement. She finds that the effect of minimum wages on both wages and employment significantly increases with better enforcement. Here enforcement is measured as the number of labour inspections conducted per worker at the state level. The variation in enforcement across states could depend on factors such as the state’s political and economic situation, and the strength of its institution.

Based on an analysis of National Sample Survey data from semi-skilled and unskilled workers in urban India, she finds that in weak enforcement regimes the wage effects and employment effects from a minimum wage are negligible. However, where enforcement is stricter, the minimum wage boosts overall wages. The effect on employment, Soundararajan argues, will depend on the structure of the job market. For instance, in districts where there is a single dominant employer and strong enforcement, a minimum wage increases employment significantly.

Her findings will have important implications for India’s minimum wage policy. A poorly-enforced minimum wage may not even improve wage outcome for workers and defeat the policy’s basic purpose. However, a well-enforced minimum wage can significantly contribute towards increasing wages and even potentially increase employment levels for low wage workers.