Decoding the minimum wage debate

This article was originally published in www.nepallivetoday.com on September 6, 2023 by Anjila Shrestha. Ms. Shrestha ​​is a researcher at Samriddhi Foundation, an economic policy think tank based in Kathmandu. The views expressed in this article are the author’s own and do not represent the views of the organization. Author can be reached at [email protected]

The recent announcement made by the Ministry of Labor, Employment and Social Security to increase the minimum wage from Rs15,000/month to Rs 17,300/ month is well received and is generally seen to be a welcome step. This was done in accordance with Section 106 of the Labor Act (2017), where it is written that the government shall revise minimum wage every two years. So, the previous jump was from Rs 13,450 to Rs 15,000.

Now, the minimum wage is set to be Rs 17,300/month (excluding for tea sector workers, it is Rs 13,893/month), the minimum wage includes basic salary and inflation allowance. Meaning, the daily wage is Rs 668/day and Rs 89/hour.

Needs vs business realities

The dispute revolves around wage demands between trade unions and business owners. Trade unions advocate for a monthly wage of Rs 26,000 due to workers’ struggles with high inflation, suggesting it would help in managing expenses, while business owners, citing Covid-19’s detrimental impact on their stability, request time for recovery before any minimum wage increase by the government.

Picture this: A small clothing shop owner employs an assistant. The monthly store earnings amount to Rs 50,000. Although the earnings look decent and enough money to pay Rs 17,300 to their employee, the same earnings must account for Rs 25,000 in inventory costs and Rs 8,000 for rent. The shopkeeper is now running in Rs 300 loss, because all the money they generated has been spent. The shop owner is now compelled to let go of the employee. This decision is purely driven by the fact that the shop’s overall expenses exceed its revenue.

This example can be used to highlight the concerns that small businesses and micro, small, and medium enterprises (MSMEs) often raise when minimum wage policies are introduced or increased. While the intent of minimum wage laws is to provide workers with fair compensation, it can also impact small businesses that operate on thin profit margins. The example illustrates that although the revenue generated by the shop seems substantial at first glance, it is important to consider the broader financial implications and the various costs associated with operation of the business.

Government officials and experts have opined that the government should be wary about the condition Nepal’s economy is in. Many manufacturing companies have reportedly shut down and many have cut production. There are manufacturing plants operating at only 50 percent capacity.

Heart of the issue

National Economic Census, 2018 reveals that Nepal’s private sector is of small enterprises, constituting 62.4 percent of the sector. Medium-sized enterprises follow at 22.9 percent, with large enterprises accounting for 14.7 percent. A study conducted by FNCCI and the International Finance Corporation further highlights that the private sector employs nearly 86 percent of Nepal’s labor force, amounting to approximately 4.93 million people.

Interestingly, the breakdown of the employment landscape shows that micro and small enterprises contribute to 4.56 million jobs, while small and medium enterprises provide 333,077 jobs, and large industries offer 41,449 jobs. Consequently, the micro, small, and medium enterprises (MSMEs), characterized by their smaller scale of production and operation, along with limited capital, collectively account for roughly 93 percent of all jobs generated by the private sector. This underscores that despite their modest size and resource limitations, MSMEs drive the highest demand for workers in the current job market.

Section 107 of the Labor Act (2017) gives way for a minimum remuneration fixation committee to be set. This committee consists of representatives from the government of Nepal, trade unions and employers’ association. What we fail to see is representation from MSMEs and SMEs that are one of the biggest job creators in Nepal. The tyranny of the minority comes into play, yet again.

The general point that is being contested now is how Rs 17,300 is still below the salary of the government assistant which is Rs 26,348. The Vice President of GEFONT has time and again expressed the demand of the union that the minimum wage should be increased to match at least the salary of the lowest level government staff. While the subject matter of salaries received by the government staff, their increments and what it means to the taxpayers, is a topic for a different day, we need to remember small MSMEs that makeup the largest portion of job creation in the private sector cannot be compared with the deep pockets of the government. The government’s inability to effectively deal with soaring inflation prices is hitting all of the citizens. That being said, the MSMEs that are grappling with the sustenance of their business and their employees cannot be expected to pay Rs 26,000 in this situation.

If the populist government determines raising the minimum wage to be Rs 26,000, all jobs paying Rs 15,000 per month will now pay Rs 26,000  because of the new law. The general public will definitely be happy, and our politician ensures an extension for his time in his big seat. But six months later, no one will be offering the same job that used to pay Rs 15,000. They can’t afford to. If prices are held constant, employers now need fewer people, each being more productive, to justify the Rs 26,000/month.

That is the issue that underlies with populist policies, in general. While undoubtedly the safety of the working class should always remain a top priority, we have seen time and again how haphazardly increasing the minimum wage has several unintended consequences. CATO Institute has listed four direct consequences of increasing minimum wage: Job loss, hurting low skilled workers, little effect on reducing poverty and increment of price for consumers.

Even internationally, there is still no agreement on how high can minimum wages be without harming workers by causing loss of employment, increase of price of goods and job replacement by automation. If you make something more expensive, people will usually want to buy less of it. And if you make labor more expensive, then employers might want less of it and if the cost of buying machinery and replacing jobs with more automation costs the employers less than paying wages they will do it.

Exploring effects: Insights from economists

In 1992, two economists from Princeton, David Card and Alan Krueger, published a groundbreaking study which looked at how there was a positive relationship between increase in minimum wage and employment rate at fast-food restaurants in two states (New Jersey and Pennsylvania)  with differing policies (New Jersey increasing their minimum wage where as Pennsylvania not imposing any such laws).

In New Jersey, the minimum wage for employees rose, while in the neighboring state of Pennsylvania, it remained unchanged. Despite the wage hike in New Jersey, the number of jobs actually grew. Card and Krueger’s research revealed that a modest wage increase didn’t result in job cuts because wages were already below the market standard. So, one possible reason for the rise in employment could be the higher wage attracting new laborers into the workforce. This study was a first of its kind, showing that increasing the minimum wage doesn’t necessarily result in job losses, which helped Card win a Nobel Memorial Prize in Economic Sciences Award.

But having said that, claims of Card and Krueger’s paper being intentionally narrow cannot be denied. Fellow Nobel Peace laureate James M Buchanan had a stern standing, he claimed that the core proposition of economics is the inverse relationship between quantity demanded and price. People buy less when prices rise and vice versa. Similar to how no physicist claims water flows uphill, few economists argue that raising minimum wage boosts employment. Furthermore, Buchanan claims Card and Krueger’s findings advocate their personal beliefs.

Another Nobel Prize Laureate in Economics, Joshua Angrist, in his book Mostly Harmless Econometrics argues that comparing employment data of Pennsylvania and New Jersey may not even be appropriate as data shows that between February and November 1992, there was a small decrease in jobs in Pennsylvania while jobs in New Jersey remained mostly unchanged. However, when looking at different years, both states experienced significant fluctuations in employment, and these changes were often different between them. This means that using Pennsylvania as a comparison might not accurately show what would happen in New Jersey if there was a change in the minimum wage.

Leaving the findings of economists based on developed nations aside, this is not applicable to Nepal, neither the monopsony in job market nor the aspect of state or federal minimum wage, or even the fact that this study only shows an increase in employment in the capital intensive part of a fast food industry.

Impacts on MSMEs and informal sector

Shifting focus back to Nepal, the concern appears to be more centered around Micro, Small and Medium Enterprises (MSMEs) being forced to close down and therefore cause employment rates to drop rather than any other factor. Larger companies can afford to increase the wage rate of their workers and simultaneously expand their workforce (assuming rational hiring practices). The cost dynamics of production adjustments play a crucial role in such.

One major concern of raising minimum wage is also the shift of laborers from the formal sector to a more informal one. The government which tries to enforce minimum wage rates even in the informal sector has no way of ensuring such a thing because the (mostly verbal) contract is between the laborer and the temporary employer. It is next to impossible to keep track and enforce the same wage rate for gig workers in the informal sector. It is difficult to enforce it even in the digital realm, the in-person dealings are not even in question. When the wages cannot be regulated, we can only hope the situation that arose during the great depression doesn’t arise back again.

Big picture

In the end, when we talk about the minimum wage debate in Nepal, it’s not just about numbers, figures and data. It’s a story woven with threads that reach far beyond just statistics. Micro, small, and medium enterprises (MSMEs) are the unsung heroes of job creation. They are trying to balance their survival with the fair treatment of their workers.

The minimum wage is not just about numbers, figures and data. It’s a story woven with threads that reach far beyond just statistics.   

What we need is an approach that understands the bigger picture that encapsulates the need to find a way for workers to have dignified lives while still keeping those business doors open. It’s about making sure that every step forward doesn’t inadvertently lead to two steps back. A balanced harmony where both workers’ well-being and the resilience of these businesses can thrive together. Having said this, it is also vital to hold the government accountable for addressing inflation’s growing impact. The consequences of inadequate actions resonate deeply within the MSME sector and wager workers alike. The government must prioritize comprehensive measures to curb inflation.