Wednesday, March 3, 2010

The minimum wages and government hirings

Many state and central governments in India have imposed restrictions, even bans, on the recruitment of typists and computer operators and advocate using contract personnel (hired through manpower contractors) for these services. However, the regulatory fiat that classifies all computer operators into a single minimum wage bracket that rises every year may actually be an example of how such minimum wage laws can seriously distort market incentives and efficiency.

Econ 101 tells us that the government mandated minimum wage floors drive a wedge between the quantity of labor supplied and that demanded, thereby leaving productive labor resources unemployed. Supporters of minimum wage though argue that in the absence of collective bargaining power for labor, such wage floors are necessary to ensure that labor are not exploited by capital owners.

I am inclined towards the view that both these explanations simplify matters considerably and do not wish to take a generic position on this issue, atleast for now. However, it is undeniable that in the real world, labor markets respond to minimum wages in different ways. And there are problems when the minimum wages are rising at a rate faster than inflation and with the indiscriminate application of minimum wages to workforce in the semi-skilled services sector.

In recent years, a substantial wedge has developed between the minimum wage for certain categories of labor and their prevailing market prices. I can think of two reasons for this, though there are surely more. One, the minimum wages have been increasing at a rate faster than the prevailing market wages as government labor departments stick to their weighted formulas to mark up minimum wages every year, independent of prevailing market rates. Second, in keeping with the expanding youth workforce, the supply of un-skilled and semi-skilled labor has been increasing at a very rapid clip. This abundance has had the effect of depressing market prices.

The poorly regulated vocational skill development sector (eg. proliferation of largely unregulated private computer training institutes) means that there exists vast variations in the quality of education imparted by different institutions. Except for a few institutions, students from the vast majority of such schools are poorly trained and therefore have a very inferior skill set. A highly differentiated market emerges for these semi-skilled people, with a small minority of employable labor and the large majority who are unemployable.

The minimum wage, by dictating a flat rate for everyone in the same labor category (say data entry operators), irrespective of the actual skills they possess, seriously distorts incentives among both employers and employees. The employers cannot discriminate among their employees depending on their relative abilities and skill endowments. Safe in the assurance that the critical determinant of their wages is acquisition of a certificate and everyone with that qualification will get the same wage, students' incentives to put in efforts to actually acquire the desired skills get skewed. Further, the employees have no incentive to improve their skills even after getting into their jobs.

The extent of incentive distortions, especially in the quality of work output, due to minimum wages is larger with semi-skilled services than with agriculture and factory labor. Take the case of computer operating personnel in government offices. There is scope for considerable variations (a full spectrum in variations) in both skill endowment and ability within each category. It is plain inefficient to sweep all computer operators under one generic, single salary slab arrangement. Government employers are forced to pay the same flat rate to all operators, irrespective of their relative abilities.

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