LESSON 10

Compensation structure and Differentials

Tutorial Activity

ASIAN LABOR UPDATE

Chapter 5: Introduction To The Minimum Wage

Learning Objective

• To study about minimum wage policy

• Does a minimum wage policy protect workers who are under pressure in the ‘race
to the bottom’ of labor standards in a globalising world economy?

• The role of Trade Union

Virtually everywhere in the world, there is on-going debate on the usefulness of

minimum wage regulation. Since structural adjustment programmes were introduced in
the 1980s to many developing countries, minimum wage regulation has been under attack
on several grounds: proponents of the structural adjustment programme argued that
minimum wage regulation did not help the poorest of poor workers, i.e. those in the
informal sector, as the regulation covered only formal sector workers; furthermore, if a
minimum wage is set at an unreasonably high level, it would have a negative impact on
employment and therefore make its overall effect on income distribution at best
ambiguous.

Particularly, as the accelerating process of globalisation forces nation states to compete

against each other to attract more foreign investment, minimum wage regulation is seen
as a possible barrier to more investment.

Before looking at the current debate on minimum wage policy, it is useful to have a brief
look at the definition, aim, and history of minimum wage regulation.

A minimum wage is a minimum level of payment established by law for work performed.
Its purpose is to protect vulnerable low wage workers from exploitation. It is a time-
based wage that usually applies to unskilled adults entering work for the first time. As a
minimum wage is established by a law, it is legally enforceable.

The key purpose of a minimum wage system is social to prevent labor exploitation and
poverty. This means the minimum wage should provide sufficient purchasing power to
enable a worker to have a basic standard of living. The minimum wage may also have an
economic objective - to motivate workers, enable them to enjoy the benefits of economic
growth, and contribute to the economy.

It is generally considered that minimum wage regulation was first developed in New
Zealand (1896) followed by Australia (1899), and later Britain (1909). As the main
objective of minimum wage regulation was the elimination of ‘sweating’, that is the
payment of exceptionally low wages, its application was usually restricted to a limited
number of particularly low-paying sectors or to selected categories of workers, such as
home-workers, women, children and indigenous workers judged to be particularly
vulnerable.

A number of developing countries also carried out experiments with minimum wage
regulation to protect categories of workers judged to be particularly vulnerable. For
instance, Sri Lanka’s Minimum Wage Ordinance was promulgated in 1927, while
Argentina introduced the Home Work Act in 1918 with a view to protecting low paid
home-workers.

However, with the exception of a few countries, minimum wage fixing remained a rarely
used and limited instrument of government policy in both industrialised and developing
countries before the Second World War.

Towards the end of the economic depression of the 1930s and after the Second World
War, the number of countries adopting minimum wage regulation grew rapidly. There
was also a trend towards extending wage protection to more and more groups of workers
and in many cases was more universal.

The early development of minimum wage regulation and subsequent expansion since the
1920s are well reflected in a series of International Labour Conventions on minimum
wage regulation by the International Labour organisation (ILO): Minimum Wage Fixing
Machinery Convention (No. 26) 1928, the Minimum Wage Fixing Machinery
(Agriculture) Convention (No. 99) 1951, and the Minimum Wage Fixing Convention
(No. 131) 1970.

In spite of impressive development of the minimum wage system in many countries,

however, it should be noted that as with industrial relations, both the exact nature and the
scope of minimum wage protection reflect the particular historical and institutional
development of the country concerned.

Some countries in Asia, for example Thailand, Indonesia, China, and Japan, have
decentralised minimum wage systems, while others like South Korea and Vietnam have a
single minimum wage for the entire country. Cambodia has minimum wage fixing
machinery only for the country’s garment and textile sector.

As seen above, minimum wage regulation had been adopted by more and more
industrialised and developing countries as a major social policy tool to protect low-skilled
workers by establishing a minimum wage floor under which no payment should be made.
But the usefulness of a minimum wage is now under question by policy-makers and
economists, as both developing and developed countries have faced a serious under-
employment and unemployment crisis since the 1980s.

The standard argument against the minimum wage system was based on the assumption
that a minimum wage above a certain level will cause unemployment and therefore
inadvertently work against poverty reduction. In the specific context of informalisation in
developing economies, a minimum wage system in the formal sector was blamed for
crowding out formal sector jobs into the informal sector.

But empirical [= practical, as opposed to theoretical] research undertaken recently did not
show a negative effect on employment by moderate increases in the minimum wage.
Also, recently the ILO undertook a multi-country statistical analysis of the effect of
minimum wages on poverty, employment, and informalisation in developing countries.

The study found that if other things were equal, the level of the minimum wage has an
insignificant effect on the level of employment. Also, the study concluded, after
analysing economic data in Latin American countries, that changes in the ratio between
the minimum wage and the average wage exert no significant impact on the share of the
informal economy in South and Central America.

This result supports the view that labour market rigidity, and more specifically low wage
rigidity, is not the major factor behind the informalisation of Latin American economies.
Regarding the effect of minimum wage on poverty, ILO analysis found that for a constant
level of GDP per capita and average wage in manufacturing, in one locality, a higher
minimum wage is associated with a lower national level of poverty.

In sum, the research findings strongly support the idea that the minimum wage may bring
positive results in poverty alleviation by improving the living conditions of workers and
their families while having no negative results in terms of employment. Also, no
evidence indicated that the level of the minimum wage relative to the average wage
affected the size of the informal economy in Latin America.

The above studies suggest that the argument against a minimum wage system in
developing countries on the grounds of employment and poverty is not convincing.

Let us examine another important argument against minimum wage regulation which is
often put forward in the context of globalisation and competitive edge. Often it is alleged
that a high minimum wage is responsible for weakening competitiveness of industries.

But is it really true?

Take the case of Thailand. At the peak of the Asian financial crisis in 1997 - 1998, there
was a heated debate on the role of the minimum wage in Thailand. One view argued that
the minimum wage was one factor responsible for falling competitiveness of Thai
industries which triggered the crisis.
The ILO conducted research to investigate relations between wages and other economic
variables. The ILO’s research revealed that it was not primarily the level of the minimum
wage but other macroeconomic factors such as a fixed exchange rate and falling
productivity of Thai industries which caused falling competitiveness, eventually leading
to the economic crisis.

At the same time, however, it should be emphasised that without developing a sound
enterprise wage structure, which encourages a cycle of skill development and
productivity enhancement, there could be a minimum wage ‘trap’ for both employers and
workers.

During the pre-crisis period in Thailand, the ratio of minimum wage to average wage in
non-metropolitan regions was extremely high (around 70 percent). Because of this Thai
trade union officials complained that workers, often with several years experience and
skills, were ‘stuck’ on the minimum wage.

Available evidence confirmed this to be the case. For such workers, the minimum wage
had thus drifted from its usual intent - to provide a wage floor for unskilled, new entrants
to the labour market.

But there are other possible consequences. For one, the function of the wage to motivate
is disrupted when the link between pay and performance is weakened. While minimum
wage increases might be seen as ‘rewarding’ workers with seniority, it remains possible
that the motivation of the wage is disturbed when there is no obvious link between pay
and performance after years on a job.

On the contrary, it is possible that higher increases in the minimum wage than in average
wages could reduce the incentive to improve skills. If either is true, labour productivity
could suffer. Thai employers, on the other hand, argued the complete opposite - that
generous increases in the minimum wage had deprived them of the ability to control their
own wage structures and to devise wage policies suited to the enterprise.

There is some evidence to support this view; employers often abandon their own wage
decisions to the government’s annual announcement of the minimum wage adjustment.
Efforts to link wages more closely to enterprise performance were frustrated.

The example of Thailand illustrates the importance of developing a sound enterprise

wage structure through enterprise pay negotiations and a good human resource
management policy, which should activate a cycle of pay increases, more motivation,
skill development, and higher productivity. Actually, when workers have no bargaining
power at enterprise level, there is a real danger that a legal minimum wage turns into an
effective maximum wage.
In Cambodia for example, the majority of workers in garments and textiles receive just a
minimum wage, which is currently US$45 per month. As trade unions are very weak at
the enterprise level, the fragmented trade union movement tends to concentrate efforts on
increasing minimum wages through tripartite negotiation with the National Labour
Council. It may be an inevitable, logical choice for an emerging trade union movement
which has very weak roots in the work place.

However, it is very clear that unions should make great efforts to improve pay bargaining
capacity at the enterprise level to achieve settlements above the level of minimum wages.
Otherwise there is a real danger that minimum wage effectively becomes maximum wage
and union organisations in the workplace will find it difficult to recruit rank-and-file
workers and convince them of the value of union membership.

This situation may suggest that the most appropriate role for a minimum wage is to
provide a defined floor to the wage structure to provide a ‘safety net’ protection for the
lowest income groups.

For this reason, an ILO publication suggests that the economic impact of minimum wages
should ideally be only a slight upward pressure at the bottom end of the wage structure,
with little effect on average wages and inflation.

Of course there is the opposite case, too. In Korea, for example, the minimum wage
accounts for only around 30 percent of average wage and therefore covers less than two
percent of the total workforce. At this low level of minimum wage relative to average
wage, we could say that the minimum wage system has failed to meet its original goal of
protecting low-wage unskilled workers.

If minimum wages are too low the objective of poverty reduction will not be achieved.
People will continue to work because they have no alternative but the result is a society
of ‘working poor’.

Therefore, minimum wage determination is a delicate issue, which should be seen in a

broader context of interplay between market forces and collective bargaining power at
various levels of economies, not in isolation from other forces at work.

In this regard, the fact that minimum wage fixing through tripartite discussion - either
negotiation or consultation - is common in many countries is important. This introduces
an element of negotiation between government, workers, and employers in the wage
setting process. Where there is good quality information and the parties genuinely desire
a common-interest outcome, tripartite deliberation could offer a mutually beneficial
compromise.

But trade unions and other parties to consultations in many developing countries face a
number of problems.
As illustrated above, in a number of countries where trade unions at the workplace have
very weak bargaining power, national trade union centres tend to concentrate excessive
effort on the minimum wage fixing process, unintentionally resulting in further
weakening trade union organisations and collective bargaining in the workplace.
Another typical problem in least developed countries is that there is often no reliable data
on economic variables to be taken into account for minimum wage fixing and adjustment.
Even if there are economic data for it, trade unions often lack the capacity to analyse
them and engage in meaningful joint discussions.

Developing power and abilities of trade unions at both workplace and national levels is
an urgent task in many countries.

After years under attack for alleged negative effect on low-paid employment, the
minimum wage regulation seems to be back in favour as a means of providing unskilled
workers with decent living conditions.

Several factors are responsible for the renewed interest in the minimum wage as a tool of
market policy.

First, several studies in the 1990s showed that the minimum wage had little, if any, effect
on creating unemployment.

Second, there is a new human rights approach that focuses on the right to have decent
employment. In developing countries, policy makers are not only concerned with the
impact of the minimum wage on employment, but also with its impact on the level of
poverty.

However, trade unions in many Asian countries face an uphill battle to win a minimum
wage system, as the globalisation process and mobility of capital put great downward
pressures on working conditions and in particular on minimum wage systems. This is a
battle for decent work for all working men and women, which will continue.

By Chang-Hee Lee, Industrial Relations Specialist, East Asia Multidisciplinary

Advisory Team, ILO, Bangkok