How viable are hiked wage rates

Populism, buttressed by dodgy economics, has become the fashion statement in politics. Last year, the Union government approved handsome “real” increases in government salary. There was little justification for doing so since the government salaries were already fully indexed to inflation and the largesse couldn’t have been justified as a reward for higher productivity. The default justification was that more money in the hands of government employees would kickstart a virtuous circle. Higher demand for goods and services would lead to expanded supply, more jobs and just possibly, more income for the rest of us. This week, the Aam Aadmi Party government in Delhi, used similar tactics to grab eyeballs on Independence Day. Evoking the high moral stance of re-distribution of wealth and the economic principle of boosting demand as justification, the government declared massive increase in the minimum wage. In effect, it imposed a “living wage”, for workers in Delhi.

The concept of a “living wage” — pegged significantly higher than the minimum wage — with an eye to decrease poverty has been used in over 100 urban jurisdictions in the United States since the late 1990s. It has also been used to set the national poverty level in India. But it is pegged at very low levels. In Delhi, chief minister Arvind Kejriwal has proposed that the minimum wages of unskilled labour will be increased from Rs 9,500 to Rs 14,000, semi-skilled Rs 10,600 to Rs 15,500 and for skilled Rs 11,600 to Rs 17,000. It needs to be mentioned that the minimum wage in Delhi is already 35 per cent higher than in neighbouring Uttar Pradesh and 72 per cent higher than in adjoining Haryana. It is true that Delhi is relatively rich. Its per capita income of around Rs 18,300 per month is the highest among the states of India and the top 10 metros. Consequently, there is a case for setting the “living wage” in Delhi reasonably higher than in the neighbouring states, purely on the grounds of equity.

The real issue is whether a 47 per cent increase is warranted and how comprehensively should the “living wage” be applied? If it is applied just to the establishments governed by the Factories Act, then it is little more than populism. There are only around 8,000 such factories in land-hungry Delhi and employment in them is static. If the intention is to enlarge the coverage of the “living/minimum wage” to all registered shops and establishments, which employ around 20 per cent (one million) of Delhi’s five million workers, then the economic consequences can be more substantial. The negative impact will be felt in price-sensitive, low value-addition segments like clothing, food and household goods, where higher wages will hurt trader profits. More importantly, will a similar “living wage” follow for the one million workers in the informal sector — household help in rich and middle class homes and in unlicensed small establishments?

Mandated high minimum wages, far above the market rate, encounter three problems. First, enforcing payment of the mandated wages depends crucially on clean, clever and consistent regulation. In its absence, it encourages the petty but crippling, corruption of “inspector raj”. Enlarging the scope of inspector raj in Delhi, even as it is being diluted in Rajasthan and Telangana state sends the wrong message to investment for increasing jobs and private sector growth in Delhi. Second, studies from the US show that the benefits are not uniform across the entire spectrum of workers. On an aggregate, unskilled workers lose the most from a high minimum wage because employment declines even as a smaller number of workers who remain employed benefit. Mandated wages rarely benefit skilled workers. Governments tend to be conservative in fixing the differential for skills.

Delhi provides only a premium of 21 per cent, or Rs 80 per day between unskilled and skilled work. The market premium is already between 75 to 100 per cent. A mason gets twice the amount as his unskilled worker — often a woman, who does the manual work. Third, pegging a price for labour far above the market rate increases the fiscal burden. This happens directly when government salaries are needlessly enhanced. But it also hits the government budget indirectly, when applied to the private sector. Higher the mandated wage for unskilled work the more attractive it becomes for migrants. With open borders, no control on migration and the Delhi government committed, rightly so, to provide a basic quality of life for all — free water, free medical care, free education, cheap electricity, improved toilets and paved roads — the resulting fiscal impact can be crippling.

One way of ensuring that market wage rates are not beggared by competition from in-migration is to licence city workers as in China. But it is difficult to do this effectively in a governance environment of pervasive corruption. If government land cannot be protected from encroachment by the mafia, there is little hope of implementing an equitable worker licensing regime. Railway stations are a good example. Try getting a licensed coolie to carry your bags at the stipulated rates and you are more likely to miss your train. The high salary of unskilled government workers already provides a wage floor. But the incremental numbers employed are limited. The trend, since 1990s when the government adopted the practices of “new pubic management”, has been to outsource non-core services i.e. cleaning, canteen, security and office support.

Worker productivity clearly increases under private management. But there is insufficient evidence that the wages paid to them reflect this higher productivity.  The apprehension is that the workers will suffer from price competition to get government contracts. This is a perverse and unintended outcome. Tightly regulating the private contracts that are funded by the government can ensure that the mandated wages are passed through to workers. And contractors do not corner the wage increase. This is how the financial viability of the enhanced wage rates should be tested before imposing them. There is little point in cultivating a small, handsomely paid labour “aristocracy”, as the CPI(M) did, whilst throttling investment and employment.