Editor’s Note: This article is a response by the Foundation for Economic Development (FED) to Prasanna Mohanty’s earlier piece, ‘Why Blaming High Minimum Wages For India’s Informal Economy Is Flawed’, published in The Core.

We released a report about how minimum wages hurt the most vulnerable workers a couple of weeks ago. Writing in The Core, Prasanna Mohanty has raised a few objections. While we are grateful to Mohanty for engaging with us, we wish that he, or the people whose opinions he has cited, had engaged with it more deeply.

Our report lays out a very simple mechanism – when something costs more than other alternatives, people buy less of it. If the government were to legally mandate that wheat is going to cost 1.5 times what people are willing to pay, more and more people would switch to rice over time, or buy wheat in the black market!

This is the problem with minimum wages – if a worker can be profitably employed at Rs 12,000, and the government mandates you have to pay that worker Rs 15,000, you cannot employ workers at a loss. You will look for other alternatives, and, over time, you will find them. We document that this mechanism is very thoroughly backed up by both empirical studies and India’s experience.

Mohanty and his advisors do not engage with this argument at all. Instead, they claim that the studies we cite are based on experiences of developed countries and, hence, are somehow invalid.

Evidence Beyond Borders

First of all, this is not the case. One of the literature reviews that we cite is based on studies from all over the world, including developing countries. The RCT on minimum wages was carried out on an online platform, with participants from all across the world. The evidence in these studies is very clear. Artificially raising the price of workers reduces demand for them, especially for the least skilled and most vulnerable, who already find it most difficult to find work at higher wages. Ironically, the scholar the author of the article cites approvingly, David Card, studied minimum wages only in the US.

Second, even if the piece was right and we were citing only developed country experience, the idea that fundamental mechanisms of economics like demand, supply and pricing do not apply, and evidence on such basic facets of human behaviour does not matter simply because it is collected in another country, is unhelpful to our ability to understand the world around us. We do not dismiss Card’s work because it was carried out in the US. We dismiss it because his methods are inadequate for his findings, as we document in our report (see also the review by Neumark and Wascher).

The author of the article is right, however, that we cannot directly compare the minimum wages between countries. After all, productivity, prices, economic activity and living standards etc., are very different in each country. Luckily, we were aware of this and therefore all cross-country comparisons of minimum wage are done after they are made comparable. For instance, when comparing with other developing countries like Bangladesh, China, and Vietnam, we divide each country’s minimum wage by that country’s GDP/capita. This tells us what percentage of average income we are setting the minimum wage at, allowing for complete comparison across countries. We find that these other countries set their minimum wage at ~50% of their monthly GDP/capita, while the Indian average is at 77%, ~1.5 times higher!

Strangely, one of the voices in the article called this use of GDP/capita absurd because workers support dependents, and if dependents are more, the ratio is worse. Even granting that bringing dependents into the conversation is somehow valid, does the gentleman believe that workers in other countries do not have dependents? Or that their GDP/capita is counted in a way that excludes those dependents?

India has one of the highest working-age populations and thus one of the lowest dependency ratios in the world, so if anything, this should be extremely favourable for us. Yet, it is not.

When Minimum Wages Backfire

Similarly, when comparing where the minimum wage stands against actual worker wages, we divide the minimum wage by what the median actual worker earns. Unfortunately, this data is available only in developed countries, so we compare against those, and find, again, that India’s minimum wages expressed as a comparable percentage (of actual median worker wages) are much higher - 3 to 8 times higher - than those in UK, Japan and the US.

Even if you don’t compare minimum wages to anywhere else, and just look at what actual Indian workers are earning, it is clear that minimum wages are set absurdly high. Would you be happy with a job that gave you 30% more money each month? Probably. Yet, we find that for nearly half (47%) of all Indian workers, if you want to give them a 30% hike over what they are currently making and employ them formally, you cannot because you would be paying them below the minimum wage.

We then study the combined effects of the mechanism that we outlined – people will buy less of something that is overpriced – with the fact that Indian minimum wages are overpriced relative to both competitor countries and wages on the ground. We find that all the predictions made by the mechanism are borne out. India has faster growth in capital-intensive sectors compared to labour-intensive ones. So people are ‘buying’ more automation, which is unusual given our large labour force. India also has far lower labour-intensive exports relative to other competitor countries, so people are ‘buying’ more of their labour than ours. India also has one of the largest informal workforces in the world, so more people are ‘buying’ more work illegally.

Are all of these effects purely due to the minimum wage? Probably not, but all the other labour regulations also push in the same direction as minimum wages, and we outline many of those in our report as well. Factors other than labour regulations matter too of course, but those do not explain why labour-intensive sectors in particular perform so poorly in India.

Last but not least, another interviewee in the article claimed that low ‘demand’ is the cause of the ills of the Indian economy, and raising minimum wages will get us more demand. This argument fails on several counts. First, as we show above, raising the minimum wage does not actually put more money in the hands of most workers; it actually suppresses their options and their productivity. Second, even if it were true, the number of formal factory workers earning exactly minimum wage is minuscule. Even with very conservative assumptions, raising the wages of one-fifth of formal factory workers by 20% would result in additional consumption of about 0.002% of GDP. This pales in comparison to the growth possible by tapping into international demand and bringing in lakhs of informally employed workers into the formal sector, which we could do with more competitive labour regulations and industrial ecosystems.

India's minimum wage policy is not protecting vulnerable workers; it is locking them out. It is pushing investment toward machines over people, driving labour into informality, and ceding labour-intensive exports to Bangladesh, Vietnam and China. We have nothing against the aspiration behind minimum wage laws; everyone wants workers to earn more and live better. But good intentions do not override basic economics.

The path to higher wages for Indian workers runs through more jobs, more formal employment, more exports, and a more competitive labour ecosystem — not through legal mandates that price the most vulnerable workers out of the market entirely. We hope this debate moves, in time, from defending a policy that sounds compassionate to asking what will actually make Indian workers better off.