Plans to impose a Rs 10,000 Minimum wage: Will it improve welfare?

By Ravi Ratnasabapathy 

The article originally appeared on Dailynews on 7 May 2015

It is reported that the Government intends to legislate a minimum monthly wage of Rs.10,000 with an increment of 25% to be imposed over the next year. An increment of Rs.1,500 is to be effective from May 1 2015, while the rest will be effected from May 1 2016.

The legislation is probably founded in good intent: improvement of the welfare of citizens. Improving the welfare of people should be one of the fundamental objectives of a Government and one that few, if any, would question.

In simple terms we may measure welfare as the standard of living or in economics, the amount of goods and services that a person can enjoy. To the average person it may appear obvious that there is a minimum that one needs to earn to pay for basic foodstuffs, rent, electricity and utility bills and other expenses to live as a human being.

The standard of living is dependent on two factors: the income of people and the cost of goods and services. If the cost of goods and services is low then people do not need a high income.

A price list from Ceylon Cold Stores dating from the 1950's or 1960's lists the price of an imported Australian chicken at Rs.3.10 per pound, haddock fillet from Scotland at Rs.3.00 per pound and ice cream at Rs.10.00 per gallon. The author recalls paying a rupee for bread and 15 cents for the bus fare to school. If costs had remained at those levels people could have lived comfortably on a few hundred rupees a month.

Therefore in striving to improve the welfare of people there are two approaches that may be taken: the increase of wages or the reduction in the cost of living. Moreover if the cost of living increases faster than wages, people will be worse off, even if wages keep rising.

Sri Lanka has a highly distorted tax structure with essential commodities and foodstuffs being taxed at high rates. The previous regime excelled at the art of taxation by stealth with “special commodity levies” being imposed on milk powder, dhal, canned fish, potatoes, onions, chillies and a host of other foodstuffs. Milk powder is taxed at Rs.135 per kg, dried fish at Rs. 102 per kg, butter at Rs.880 per kg, cooking oil at Rs.110 per litre.

This is quite apart from VAT and other levies that add a further 15%-16% to costs. The taxes form a significant part of the final price of the goods. The current regime has cut some of the taxes but there is much more that could be done.

The problem that the Government faces in cutting taxes is that they have no means of paying for the bloated public service. The Government spends 54% of the tax revenue just paying the salaries and pensions of public servants.

Due to high levels of debt, interest cost takes up a further 38% of tax revenue.There are also huge inefficiencies and waste in the public sector. Sri Lankan Airlines lost Rs.30 bn in 2013, the cost of which is passed on to people as higher taxes.

The cost of living can be reduced significantly, with consequent improvement in welfare of the people, if taxes were cut but in order to do so waste and inefficiency in the public sector must be reduced.

Returning to the minimum wage, in order to impose a minimum wage, there needs to be employment.

The Government can impose minimum wages but this will have little effect in improving welfare if people are unemployed. There is no point in absorbing the unemployed into public service, as the previous regime did on grand scale because paying for this means taxing-and impoverishing the population at large.

Therefore the first step in poverty reduction is to ensure that jobs are created in the private sector, the second step being to control the cost of living.

The problem is that if the minimum wage is set too high and economic activity that takes place at low wage levels may become unviable.

Low wage jobs generally employ unskilled labour; if jobs are lost it is the poor who will suffer. It is better to have a low-paying job and some income rather than no job and no income.

As liberal economist Paul A. Samuelson wrote in 1973, “What good does it do a black youth to know that an employer must pay him $2.00 per hour if the fact that he must be paid that amount is what keeps him from getting a job?

In 2003, South Africa imposed minimum wages in agriculture to provide protection for workers to a sector with lowest average wages in the country.

A study on the impact of this by Bhorat, Kanbur and Stanwix concluded that while farmworker wages rose by approximately 17% as a result of the minimum wage, employment fell significantly, by over 20% within the first year.

A study of the impact of minimum wages in Indonesia by Asep Suryahadi, Wenefrida Widyanti, Daniel Perwira and Sudarno Sumarto reached similar conclusions. Since the late 1980's minimum wages had become an important plank of Indonesian government policy. While minimum wages succeeded in increasing average wages employment declined.

According to the study, a 10% increase in minimum wages resulted in a more than one per cent reduction in employment for all categories of workers except white collar workers.

Given the evidence available, the Government's decision to impose a minimum wage must be viewed with caution. If the minimum wage is significantly above market rates it will cause a decline in employment. The current wage level of Rs.10,000 is fairly low and anecdotal evidence suggests that its impact on employment will be small but once such legislation is in place the question of increments comes up.

A politician looking for quick votes in an election year may promise a high increase to the minimum wage which may reduce employment in the long term, to the detriment of the poor.

This policy, taken together with the ill-conceived taxes imposed in the budget sends a negative signal to investors. Investment in new business is needed to create employment, so sending the right signals is important. Not only could this policy destroy existing employment it could also be a dis-incentive to the creation of employment in the future.

It is advisable that the Government reconsider this policy. 

Ravi Ratnasabapathy trained as a management accountant and has broad industry experience in finance. He is interested in economic policy and governance issues.