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Wage Policy and Inflation – How are they related?

Wages, salaries and inflation! As common man we naturally expect higher salary with higher inflation. The recent (almost run-away) food inflation forced even the upper middle class to cut on their food consumption and leisure outings. The condition of the poor is unimaginable. The old saying of the basic necessity of having ‘dal-roti’ is no more a cheap basic. Pulses are actually a food of the rich now! Salaries are rising and so are prices of goods and services. The economics of wages and inflation is interrelated.

The Concepts of wages

There are three different concepts of wages-

1) The minimum wage- Minimum wage is the least of all wages. It is the base wage that the employer has to pay so that his workers/employees can fulfill the basic needs like accommodation, food and clothing of a small family. Minimum wage is not market clearing wages. They are regulatory wages to ensure that market wages do not fall below subsistence.

The Minimum Wages Act 1948 states the following norms for fixation and revision of minimum wages-

  • Three consumption units for one earner.
  • Minimum food requirements of 2700 calories per average Indian adult.
  • Clothing requirements of 72 yards per annum per family.
  • Rent corresponding to minimum area provided for under govt.’s Industrial Housing Scheme.
  • Fuel, lighting and other misc. items of expenditure to constitute 20% of the total minimum wages.
  • Supreme Court ruling in 1999 added-
    • Children education, medical requirement, minimum recreation including festivals/ceremonies and provision for old age, marriage etc. should further constitute 25% of the total minimum wage.
    • Local conditions and other factors influencing the wage rate.

The minimum wage rates have to be revised at an appropriate interval not exceeding five years.

2) The fair wage- The fair wage is above the minimum wage and it takes into consideration the paying capacity of the employer.

3) The living wage- The living wage which is the highest of the three, is aimed at providing a comfortable living for the employer and his family. It includes providing health, educational and social facilities.

Article 43 of the Minimum Wages Act 1948 states that the State shall endeavor to provide all workers, a living wage, conditions of work ensuring a decent standard of life and full enjoyment of leisure, and social and cultural opportunities.

Traditional wage plan include piece wage or time wage plan. Whereas modern wage plan includes skill based wage plan, competency based wage plan and broad banding. Variable compensation programs are designed to reward and motivate employees according to their performance.

Variable Dearness Allowance (VDA) – In order to protect the minimum wages against inflation, the central government has made provision of Variable Dearness Allowance (VDA) linked to Consumer Price Index Number for Industrial Workers. VDA is revised periodically twice a year effective from 1st April and 1st October in the central sphere.

Wages and Inflation

Inflation and wages are interrelated. High inflation demands increase in wages to maintain the current lifestyle at higher prices. When wages are increased it further fuels the existing inflation, by increasing demand.

Currently India is facing twin problem of price inflation as well as wage inflation.

There are major wage disparities in the country. Wages differ from region to region and between different sectors too like the organized and the unorganized sector, the Public sector and the private sector. While the minimum wages are set by government legislation, the higher wages/salaries in the private sector are entirely according to the employer’s capacity to pay and the acquired skills and proficiency of the employees.

There is no upper limit of wages. Since skilled labor is scarce, private firms compete for skilled human resource.

They try to attract and retain skilled employees by offering them high salaries and many other benefits like higher education, luxury accommodation, transports, club memberships etc. The ‘living wage’ is skyrocketing. It’s a phenomenon which India is witnessing since 1991 when the economy was opened up and the private sector became a major player.

At the lower end too the government keeps revising the minimum wages to keep pace with the inflation/ rising cost of living. Minimum wages have risen from Rs. 40/day in 1998 to Rs.45 in 1999, Rs. 50 in 2002, Rs. 66 in 2004, Rs. 80 in 2007 and Rs. 120/ day at present for unskilled labor.

Raising wages is one way of improving the standard of living of the masses. Another is providing employment at the current wage. The government is running several schemes like the National Rural Employment Guarantee Scheme (NREG), to provide gainful employment to the unskilled labor living in poverty.

Wage and salaries are the means of expenditure. These create demand in the market.

The rise in gainful employment and wages of the marginal class and the high salaries of the upper class obviously result in increase in the total demand of goods and services.

Such is the dilemma of developing countries like India. On one hand there are supply constraints like flood, drought and low production capacity and unskilled labor; on the other hand the government has to work towards reduction of poverty, unemployment and lack of skilled human resource. Supply constraints mean shortage of required goods and services, leading to high prices; and providing employment and high wages means creating demand. As it is the existing supply is less than the existing demand.

When salaries are hiked the demand increases further to such an extent, fulfillment of which is not possible for the economy in the short run. This phenomenon can be termed as overheating of the economy.

The other impact of increase in wage is on the wage bill of the employer. Increased wage bill adds to the final cost of production of the product or service, thus raising its market price, fuelling inflation.

Thus, it is not just poor monsoon or drought or rising fuel price that is the cause of inflation. Wage inflation is one important factor too. Wage and inflation affect each other. Production capacity has to be increased significantly to balance and match the increase in demand caused by increase in wages. Otherwise wage hike will only lead to further inflation.

There has to equal focus on both- increase in supply as well as rise in employment and wages. Otherwise there will be no end to the ever rising rate of inflation.


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4 Responses

  1. Firstly thanks for this very informative article. I have a doubt in this regard. I work for an American MNC in Hyderabad, India. I’d like to know whether there are any provisions under the current labour laws that require an increase in a component of the salary to accomodate the inflation in the current economy. For example: the current hike in petrol prices or the increase in food prices etc. Thanks in advance.

  2. The article was really good.I need some information on calculation of basic need wages for industrial workers in India. Can you please provide me with the details