Minimum Wage: Good intentions, bad outcomes

LightCastle Analytics Wing
February 17, 2014
Minimum Wage: Good intentions, bad outcomes

This has been first posted on The Asif Khan Blog

Recently, after rounds of negotiations, the minimum wage for blue-collar RMG workers was increased by 77%. The humanitarian in me rejoiced at the news, as I believe that their income was too low to support a decent standard of living. These people have been shedding blood, sweat, and tears for our country and quite frankly they deserve better.

However, the economist in me was not so sure about how much it would help them or even the economy itself. Before you pigeonhole me as the stereotypical “crony capitalist,” I would ask that you at least peruse my reasoning.

Let me start with a bit of theory. Free market economists, particularly of the Austrian school of thought (Ludwig von Mises, Friedrich Hayek, etc) speak vehemently against any sort of government intervention.
Their logic, when applied to minimum wage, is simple. Setting a price above the market-determined price will take the market to disequilibrium and thus demand will be lower than supply.

Effectively, this would lead to higher unemployment and therefore a “deadweight loss” will be created. Now that I have covered the theoretical gibberish, it is time to discuss real-life implications.
In reality, unemployment did clearly increase after the hike in minimum wages. Most RMG factories laid off (close to 20%, if my sources are to be believed) employees in a desperate attempt to protect their thin profit margins. It was mostly employees from the unskilled category who were laid off. Entry requirements were also raised.

For example, in one particularly large factory, the minimum requirement for educational qualification was raised from individuals who had passed through Grade 6 to SSC graduates.
What this suggests is that the more skilled workers are being better off at the expense of the unskilled ones when minimum wages are raised. But the whole worker community is “not” benefiting from the wage hike, which would have been the ideal situation.

This would have been okay if the semi-skilled workers who still have a job got the full benefit of the hike. Unfortunately, my hypothesis is that their cost of living, particularly rent (the largest expenditure) will adjust upwards quite sharply. This is because the rapid urbanization and dense concentration of people give a lot of bargaining power to the landlords.

Thus, when wages increase, they can raise rents as well. I have already seen the effect of the wage hike on inflation in the CPI figures for January 2014. Non-food inflation rose by 1.7% MoM (month over month) driven mainly by “Gross rent, fuel, and lighting” which grew to a staggering 3.37% MoM. Given that energy prices have not been adjusted upwards recently, I can conclude that the hikes in rent drove most of the increase.

You can question my conclusion by saying that there is a seasonality effect on rents because it is the start of the year. My counterargument is that an increase of such magnitude is quite unprecedented even when we look back at the numbers for past years.

My final argument is that some of the factories with a weak financial position will completely go out of business with the wage hike. All workers working in these factories will be out of work and there would be nobody to hire them as the industry as a whole is shedding its workforce.
For these people, getting a lower wage is still better than getting no wage at all. One such early indicator is the fact that many factories have still not been able to comply with the directive.

Minimum wage is a great example of good intentions but bad outcomes. In the words of the economist Henry Hazlitt:
“You cannot make a man worth a given amount by making it illegal for anyone to offer him less. You merely deprive him of the right to earn the amount that his abilities and situation would permit him to earn, while you deprive the community even of the moderate services that he is capable of rendering. In brief, for a low wage, you substitute unemployment. You do harm all around, with no comparable compensation.”

What then is the solution? There is no magic answer. We have to first try and figure out why exactly the market priced the wages for our garments workers at such a low level.
I am definitely no expert on the RMG sector but would point to the following factors:
1. The large population base of the country leading to an oversupply of workers.
2. Lack of education resulting in very low productivity compared to peer countries.
3. Infrastructure and energy bottlenecks slowing down growth of entrepreneurial activity.
In my honest opinion, focusing on supply-side policies such as education, healthcare, and training to boost the long-term productivity of the workforce would lead to a better outcome than a one-off hike in minimum wages.

WRITTEN BY: LightCastle Analytics Wing

At LightCastle, we take a systemic and data-driven approach to create opportunities for growth and impact. We are an international management consulting firm which creates systemic and data-driven opportunities for growth and impact in emerging markets. By collaborating with development partners and leveraging the power of the private sector, we strive to boost economies, inspire businesses, and change lives at scale.

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