MINIMUM WAGE: GOOD INTENTIONS, BAD OUTCOMES (TIM HARFORD COMMENT INCLUDED)

, Human Capital

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 a 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 urbanisation and dense concentration of people gives 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 its hikes in rent that drove most of the increase.

You can question my conclusion 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 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 outcome. 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 long-term productivity of the workforce would lead to a better outcome than a one-off hike in minimum wages.

Now for the more interesting part. Here is the email exchange between me and Tim Harford, author of the The Undercover Economist. 

Dear Mr Tim,

I loved reading “The undercover economist” and also read a piece written by you advocating foreign buyers not to desert Bangladesh. Now I have a personal request to make. I recently switched from a NY based investment fund to a local stock brokerage in Bangladesh with the dream of improving the knowledge of finance and economics in the country. I also opened a blog to promote this and got a comment from Aswath Damodaran. I was hoping to get a similar comment from you which would be a big motivation for me and the entire country. I have a question for you which I cannot really figure out and I am hoping to get an answer from you.

 

Problem: Recently the Bangladesh government increased minimum wage by 77%. This sounds great because these workers shed their blood, sweat and tears for the country. However being influenced by Austrian economics I feel that this wage hike would not help the workers because 1. Their rents (large component of expenditure) would adjust and 2. A lot of workers (hearing about 20% in some cases) are being laid off. Furthermore we should also see deadweight loss.

 

So what then is the solution to help these workers? The only thing that comes to my mind is supply side policy like better education, healthcare and training but these are mid to long term policies. Would really love to hear your thoughts.

 

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Hi Asif,

Sorry for the slow response. I agree, an effective short-term solution looks elusive. In the longer term the answer is surely “economic development” but of course we don’t know very much about how to promote that, either…
Kind regards,
Tim Harford

Tim Harford
Senior Columnist, The Financial Times
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