Minimum Wages | When labour laws price out labour

Minimum wages have been viewed as an essential labour protection code. But they have ended up pushing more employees into informal employment. India’s policy on minimum wages must reflect market realities and regional disparities

Following the April protests in Noida by workers demanding higher wages, the Uttar Pradesh government raised the minimum wages in the state by 21%. Supporters of the move expected employers to pay employees more, ensuring a better wage for the least well-off workers.

As the dust settles, the ground reality looks quite different. Many workers report their paid workdays dropping from around 20 a month to 15, or even as low as 10. Others have been moved to informal arrangements with cash payments and no contracts. The minimum wage went up; the workers are worse off.

Before dismissing this as employer misconduct, it is worth understanding the situation they face.

Raising informality

Many manufacturing units in Noida — garments, light engineering, assembly — are labour-intensive, export-oriented, globally competitive businesses that run on thin margins. A typical garment export business operates at a profit margin of 4-5% with labour making up 25-40% of the cost. A sudden 21% increase in that cost, with no corresponding increase in worker productivity or in the price their buyers abroad will pay, turns already slim profits into losses. When running a business formally at the mandated wage becomes unviable, many employers end up committing the ‘crime’ of hiring workers at a wage those very workers are willing to accept.

A recent report by the Foundation for Economic Development examined data across 14 of India’s largest states and found a consistent pattern: when the minimum wage is set above what most employers can afford to pay, it does not raise wages. It raises informality. And India’s minimum wage, the report finds, is set very high.

Across those 14 states, between 40% and 79% of workers currently earn below the minimum wage — nationally, the figure is 64%. For nearly half the workforce, even a 30% raise over today’s earnings would still leave their employment illegal. The minimum wage is not functioning as a floor or safety net in any real sense; it is instead a barrier that most workers do not yet have the skills to pass, and it is contributing to what we are seeing play out in Noida: informal work where no legal protections apply.

High floor wages

This would matter less if the minimum wages were only modestly above prevailing wages. They are not. India’s minimum wage stands at 77% relative to per-capita GDP, against a competitor average — Vietnam, Bangladesh, China — of roughly 50%. In developed economies, minimum wages typically sit at 25% to 60% of the median wage. In India, the minimum wage is 169% of what the median casual worker earns — the category of worker most in need of formal employment. We are, in effect, artificially pricing labour as though our workers are much more skilled and productive than they actually are.

The consequences are visible in aggregate data. India’s informal workforce stands at roughly 88% — much higher than other lower middle-income economies like Vietnam, Thailand or Mexico. Labour-intensive sectors like apparel, footwear and leather, which could absorb millions of the eight to 10 million new workers entering the labour force each year, grew at 7-9% between FY2014 and FY2024, while capital-intensive sectors like automotive and metal parts grew at 13-14%.

India’s structural transition out of agriculture over 30 years after the 1991 reform has been 40% slower than China’s over an equivalent period. While high minimum wages are not the only issue — other inflexible labour laws and the broader business environment matter too — they are the clearest manifestation of the same underlying problem: when we use laws to raise the cost of formally hiring low-skill workers well above the real value they can add, firms cannot hire them. Instead, they ‘hire’ machines or high-skill workers, or just go somewhere else without these restrictions.

Formal employment

So, what is a solution here? In this case, an economically efficient solution is to allow workers to freely negotiate wages with employers. This will give the most disadvantaged workers an opportunity to gain skills in the only place it really happens: a job. A negotiated wage, even if it starts below what the government thinks is appropriate, would bring millions of workers into formal employment for the first time — with contracts, provident fund contributions, and legal protections they currently have no access to. Workers already earning above the floor would be unaffected.

An expensive alternative would be to replace further minimum-wage hikes with direct wage subsidies. If the government pays a per-worker subsidy, at least demand for workers would increase rather than fall, the way it does with minimum wages. Finally, any national floor wage set under the Code on Wages, 2019, should reflect regional conditions. A single uniform floor set above the actual wage in poorer states will only make most of those workers legally un-hireable because their skills and productivity cannot yet command the high wage that is mandated by the law. Instead, a flexible national floor wage that recognises these disparities would let workers in poorer states climb the first step on the job ladder.

The choice before policymakers is not between high wages and low wages. It is between legal protections that exist on paper and jobs that exist in practice.

Faisal Khan is a Senior Team Lead, and Yuvraj Khetan is a Team Lead, Foundation for Economic Development.

Disclaimer: The views expressed above are the author's own. They do not necessarily reflect the views of DH.