#TIL:What is a wage subsidy v/s a minimum wage?

By Sreelakshmi R.

In these COVID-19 times, we see many macro solutions being embraced by national governments to mitigate the economic fallout. Wage Subsidies and Minimum Wages are hot topics in these discussions. What is a wage subsidy and how is it different from a minimum wage standard? The difference lies in their usage- the former is used in order to stimulate hiring in the economy, while the latter is useful to better the quality of jobs in the economy.

The wage subsidy is typically derived from tax revenues and disbursed by the government to businesses. The government essentially pays part of the worker’s wages to the business to retain workers in times of economic distress. This leads to a reduction in the firm’s wage bill, preventing the firm from laying off workers, and at worst, furlough them. The government usually overvalues the labour in the market and overpays for the amount of work performed, with a special intention to reduce poverty or inequality. Therefore, it increases the wages to workers, thereby driving up cash in the hands of the consumers. Therefore, a wage subsidy is a tool used in times of economic stress or prolonged periods of unemployment, to create demand for labour. This is an interesting instrument that has been adopted and announced by various governments such as in the UK, Australia, New Zealand, Canada and the USA, in their COVID-19 stimulus packages. A wage subsidy has the capacity to reduce welfare transfers made to the economically weak sections of society, and also helps the economy by boosting consumption. Overall, a wage subsidy is a good incentive during a demand shock, such as now, when demand in the economy has plummeted.

A minimum wage, on the other hand, costs nothing to the taxpayers, and hence is a good look politically on the government. However, employers incur all the costs of a minimum wage, which can restrict hiring. This adversely affects the demand for labour and consequently, the consumption level in the economy. Minimum wage calculations are also fraught with multiple variables which are difficult to control. While a minimum wage can uplift workers significantly out of poverty, it also is prone to employers cutting corners in many ways under a minimum wage regime. A cover story in the Time Magazine last year outlines how some industries are circumventing the minimum wage rule, which signals its vulnerability to misuse.

Therefore, many governments prefer to announce a wage subsidy rather than set a minimum wage, as a wage subsidy benefits both firms and individual workers while a minimum wage could benefit only a few workers. This is crucial in the time of recovery following the economic effects of the COVID-19 pandemic. Each country chooses its instrument considering its fiscal position, implementation infrastructure and prevalent compliance practices.

Today I learnt (TIL) is a weekly series by OMI that brings you interesting nuggets of information that you didn’t know you needed.

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