You cannot legislate away poverty

Of all the proposals I have heard to abolish poverty, the simplest comes from a friend in an NGO. Why not raise the minimum wage high enough to put everybody above the poverty line? It sounds so simple, elegant and painless. Alas, it will not work because of the law of unintended consequences. I was unaware of this irritating but relentless law in my own youth, when I was a woolly-minded liberal dreaming up instant fixes for poverty. It did not occur to me that if eradicating poverty was so simple, it would surely have been done centuries ago.

The Emperor Tughlak tried something of the sort by decreeing that silver was equal in value to copper. He thought poor people holding copper coins would instantly become as rich as those having silver. Instead rich businessmen quickly submitted copper coins to the treasury and demanded silver in return. Soon the treasury was empty of silver, the rich had got richer and the poor were as badly off as ever. Tughlak had not thought through the unintended consequences of his decree. He failed to realise that the fundamental economic fact — that silver is relatively scarce and copper relatively abundant — cannot be changed by mere legislation.

Consider a state where the casual labour rate is Rs 30 per day, and casual employment averages 150 days per year. A typical labourer will earn Rs 4,500 per year, and be in poverty. Now imagine a benevolent chief minister who seeks to abolish poverty by doubling the minimum wage rate to Rs 60 a day, and enforcing this (a tough task). Will the earnings of workers double?

Alas, no. If the price of anything (including labour) rises, the demand for it will fall, other things being equal. If you double the wage rate, employers will sack workers, mechanise and automate production to reduce labour use. Workers in high-productivity jobs may end up with higher pay. But many more will lose their jobs. Casual workers may find the demand for their labour falling from 150 days a year to maybe 70 days, in which case their annual earnings will actually fall even though their daily rate has doubled. The longer term effects will be worse. Employers will stop investing in the high-wage state and shift to other states with lower wage rates, with disastrous long-term effects. So, a well-intentioned aim to abolish poverty may actually worsen it.

If you doubt this, just look at the example of Kerala. Historically, it sought to be pro-poor and pro-labour in the most aggressive fashion. It had the most extensive land reforms. It encouraged trade unions even at the rural level, and abetted curbs by unions to increase employment (such as forbidding people to pick up their own suitcases at railway stations). Rural wages were jacked up to the highest levels in India. This was supposed to abolish poverty.

Alas, the law of unintended consequences came into play. Farmers faced with rising wage bills shifted from labour-intensive crops like rice to plantation crops (like coconuts) that use very little labour. All innovation went into ways of reducing labour use. Industries stopped investing in the state.

Traditionally, Kerala employed thousands of people in processing cashew and coir. But high wages induced a migration of factories and jobs to Tamil Nadu, where wages were far lower. Kerala made it illegal to move produce across the state border. Like most laws defying economic realities, this did not work: vast quantities were smuggled into Tamil Nadu. Jobs and factories shifted out.

Worse, high wages in Kerala induced a large influx of Tamil labour, ready to work for less. This further reduced the employment potential for locals. Thus well-intentioned policies aimed at reducing poverty created economic stagnation. Talented Keralites migrated to other states, and later to the Gulf, for employment. This converted Kerala to a postal order economy, dependent on remittances from emigrants. Remittances total Rs 15,000 crore a year, and ward off poverty. But this is not the way pro-labour policies were supposed to reduce poverty.

Kerala has the highest literacy and lowest infant mortality in India. Such fabulous social indicators give it the potential to become an Asian tiger. In fact it is an Asian turtle. If you wish to understand why you cannot simply legislate away poverty, study Kerala. Some readers will ask, how have Europeans and Americans raised wages without suffering adverse consequences? The answer lies in rising productivity. If the productivity of labour goes up, employers can pay more and yet remain competitive. The key to reducing poverty lies in raising productivity. That will raise wages sustainably. Legislation will not.

What do you think?