Minimum Wage Threshold: Employment Effects Turn Negative Beyond 35% of Sectoral Average Wage
SDG 8: Decent Work and Economic Growth | SDG 10: Reduced Inequalities
Institutions: Ministry of Labour and Employment (MoL&E) | NITI Aayog
The IMF Working Paper, “Minimum Wage and Employment: Sectoral and Regional Perspectives,” analyzes the impact of minimum wage changes across European countries by exploiting variations in the minimum wage to average wage ratio across sectors and regions. The study finds that on average, minimum wage increases don’t cause job cuts right away, but they consistently lead to job losses in the medium to long term (after about one year).
The analysis identifies a clear threshold effect at the sectoral level:
Employment outcomes become negative when the minimum wage is already above 35 percent of the sectoral average wage. This signals the point where the cost shock becomes binding for firms.
The effects are highly heterogeneous: large minimum wage increases tend to boost employment for young workers (mostly young men) in the short term, but they have more detrimental effects on women and older workers in the medium term.
At the regional level, employment losses are primarily driven by a decline in the labor force participation rate (activity rates), rather than an increase in unemployment. In other words, when the minimum wage is high, it often discourages people, especially in low-wage areas, from even looking for work, leading to a decline in the number of people participating in the labor force.
Policy Implications and Recommendations
Given these heterogeneous impacts, the paper urges caution in setting a uniform national minimum wage. The analysis strongly suggests the following policy shifts:
Differentiated Minimum Wages: Policymakers should consider differentiated minimum wage policies across sectors and regions to mitigate adverse employment outcomes, citing that large economies like the U.S., China, and India already implement regional minimum wages.
Complementary Policies: Minimum wage policies alone cannot fully address poverty. They must be complemented by targeted income support programs (such as the Earned Income Tax Credit in the U.S.) and active labor market policies (like targeted short-term training programs) to support low-income households without distorting labor demand.
Adjustment Management: Policymakers must recognize that firms initially adjust labor costs by reducing working hours rather than immediate headcounts
As India uses regional minimum wages, this research provides a critical quantitative benchmark for wage setting. Policymakers must utilize detailed sectoral and regional wage data to ensure minimum wages do not exceed the binding threshold (35%) relative to local average wages, thereby mitigating job losses and preventing a decline in the formal labor force. Furthermore, minimum wage policies should be explicitly complemented by targeted income support programs and active labor market policies (like short-term training) to address poverty without distorting labor demand.
What is the significance of the 35% “bindingness” threshold for minimum wage policy?→ The 35% threshold, derived from the paper’s quantitative analysis, represents the point at which a minimum wage ceases to function primarily as a poverty-reduction tool and begins to cause measurable damage to employment. When the minimum wage exceeds this threshold relative to the local sectoral average wage, firms often respond by either reducing working hours or scaling back headcounts. This threshold highlights the critical importance of tailoring minimum wage setting to local market conditions.
Follow the full report here: Minimum Wage and Employment: Sectoral and Regional Perspectives