Wages in Economic Theory and Reality: Some Issues

Wages is the payment made to a labourer for the number of hours worked ‘ sowing seeds, rolling tobacco, developing computer software or providing medical care in a hospital. How are these wages determined’ Are they determined in a similar manner as that of commodities’ That is, are they determined based on some sort of demand and supply mechanism’ Or, are they predominantly set by non-economic forces which are not easily quantifiable’ This blog post looks at the dominant neoclassical or marginalist viewpoint and contrasts it with the theoretical approach of classical economics. In this light, the post examines certain characteristics of the Indian economy relating to labour and employment.

The basic principles of neoclassical economics tell us that the price and quantity demanded and supplied of a commodity are determined by the intersection of its demand and supply curves. This is the demand and supply approach to economics. When extended to labour, the intersection of the demand and supply curves of labour is supposed to determine the wages per hour (the price of labour) and the number of hours worked (the quantity of labour). Therefore, an increase in the demand for labour relative to its supply is expected to raise the wage rate and a relative increase in supply of labour (say, from an increase in the working population commonly termed the demographic dividend) leads to a fall in the wage rate.

Classical economics, a distinct theoretical framework in economics, has a very different view of wages. It largely considers wages as an exogenous variable; that is, wages are not determined by market forces ‘ demand and supply of commodities or of labour. Of course, temporary changes can be brought about by market forces. In the theoretical world of classical economics, wages are determined primarily by socio-cultural factors such as trade union strength, the collective notion of minimum wages for different occupations and the society’s views on trust, risk, etc. In this theoretical world, which to me, seems closer to the reality, an improvement in social institutions lead to an increase in subsistence wages. Wages, in this framework, has a subsistence (relatively fixed) component and a surplus (relatively flexible) component. Hence, classical economics allows for an increase in wages, in its surplus component, when GDP is rising on account of higher labour productivity.

A conflict is present in the distribution of GDP between workers and capitalists. Neoclassical economics eliminates this conflict by recourse to marginal productivity theory. By employing logically fallacious concepts (especially of capital), a theory of distribution has been erected where both labour and ‘capital’ are ‘justly’ remunerated. In this framework, trade unions distort the market and causes injustice! According to classical economics, the presence of strong trade unions and fair labour laws ensure that workers get a fair share of productivity gains, which will otherwise entirely go as profits of the capitalists. The Global Wage Report 2012/13 published by the International Labour Organisation (ILO) notes that in several countries wage rises have not matched the increase in employment and productivity (see especially p. 28).

There are enormous disparities in wage rates across the states in India, with Kerala paying relatively high wages. One reason for the high wages is the presence of strong trade unions. As per the Labour Bureau (as part of the Rural Labour Enquiry) report on ‘Wage Rates in Rural India’ for September 2012, the average daily wage rates for men for engaging in sowing in Gujarat is 132 rupees; in Kerala, it is 500 rupees; and in Tamil Nadu, it is 222.02 rupees. A carpenter in Gujarat is paid 233.33 rupees daily; in Kerala, he is paid 514.05 rupees and in Tamil Nadu, he is paid 388.6 rupees. The differences are starker with respect to unskilled labour: a male unskilled worker in Gujarat gets paid 109 rupees; in Kerala, he earns 411.32 rupees; and in Tamil Nadu, he earns 223.54 rupees. The corresponding wages for a female worker are: 101.71 rupees in Gujarat, 266 rupees in Kerala and 159. 76 rupees in Tamil Nadu. Note the gender-wage inequality in Kerala. Also, the economic condition in rural Kerala is significantly better than rural Tamil Nadu; therefore, the statistics will have to be interpreted with some restraint.

Subsistence wage, as a concept, has enormous theoretical and practical significance. In fact, the legislations pertaining to minimum wages in India ought to look at socio-cultural factors too, such as gender, caste, geographic location, kind of labour (formal vs. informal, rural vs. urban) and so on. The enforcement of minimum wages has been beset with difficulties as evident from a recent study (published in 2011) by Patrick Belser and Uma Rani; the proportion of salaried workers and the proportion of casual workers below the minimum wage at the national level is 25.3 and 50.6 per cent respectively. Discussions on and about subsistence wages, and by extension, on minimum wage legislations are much needed. Moreover, discussions surrounding subsistence wages can also result in more dignified definitions of poverty and minimum wages.

Kerala’s Economy: Crouching Tiger, Sacred Cows


Kerala’s Economy: Crouching Tiger, Sacred Cows

Edited by Sunil Mani, Anjini Kochar and Arun M. Kumar

DC Books

Price: Rs. 195


This book contains articles which relate to the Economic development of Kerala. I have posted those facts and thoughts which I found interesting.




The state has created 12% of all new non-farm jobs in India over the 1998-2005 period, no mean achievement for a state that is home to only 3.5% of the county’s population.


The state’s poverty ratio is now 12.72 per cent, down from 60 per cent in the early seventies. Its per capita income, at Rs 22,000, exceeds the national average. If remittance income is included, per capita income is 60 per cent above the national average.


The contribution of agriculture to the state’s GDP fell to about 20%. The major portion of the state’s GDP is driven by services. While the service sector grew by 13.8% in 2005-06, industry and power grew by a mere 1.3% and agriculture by 2.5%.




An author, Arun M. Kumar calls for attention in the following five areas- nurturing a culture of entrepreneurship, making Kerala more attractive for non-Keralites, making it easy to do business in Kerala, creating a stimulating educational environment for the college going population and by involving expatriate Keralites so as to promote development.


Another author M N V Nair, talks about ‘patronage dispensation’ which he says is the philosophy of governance pursued by the elites, who consists of political functionaries, administrative bureaucracy, organized business, community and caste organizations and trade unions. He goes on to say that this ‘elite’ lives off the ‘influence peddling’.


K. Pushpangadan and M. Parameswaran talk about the ‘virtuous cycle of human development’ which facilitates rapid growth; as Kerala’s progress is in contrast to the accepted notion that ‘economic growth precedes human development’. ‘The authors suggest that the linkage is that human capital development resulted in migration that brought in remittances to the state which in turn facilitated economic growth.’ They posit that ‘dependence on remittances carries the risk of external shocks.’


Sunil Mani talks about the infocommunications sector in Kerala. He says that ‘Kerala has the highest teledensity (telephones per thousand people) among all Indian states.’ ‘Residential customers in Kerala get electricity at the cheapest rates in India’ writes V. Santhakumar.


My conclusions

The book portrays a growing picture of Kerala Economy. The authors suggest several measures to sustain this growth. It is a good read for those who want to get an in depth analysis of the economy of Kerala.

The Economics of Remittances


According to Wikipedia, Remittances are transfers of money by foreign workers to their home countries. Remittances (also known as current transfers) include worker’s remittances and other private transfers on the current account. [Gupta 2006]


The Indian scenario

Remittances to India have increased at about 13 per cent a year since 1991, making India one of the largest recipients of remittances in the world. They have been the most stable type of external flows in India. They have been crucial in improving the current account and in the consequent build-up of foreign exchange in the last few years.


The effect of remittances on output and employment generation would depend on the end-use of the transfers. The effect would be larger if remittances are geared more toward investment expenditure.


In terms of percentage of GDP, remittances equaled about 3 per cent in 2003.


[These are excerpts from Poonam Gupta’s ‘Macroeconomic Determinants of Remittances‘ which came in the EPW.]


The Kerala scene


The great exodus of Keralites to the Gulf Countries during the 1970s oil boom was to a large extent possible because of the benefits these workers had gained from growing up in Kerala (better health and education, and more awareness of opportunities beyond their state). The money they send back today makes up 25% of the state budget, and one third of all remittances to India. It has not only helped to stimulate consumption levels in Kerala, which are among the highest in country, but it has also kick-started the boom in the tertiary (or service) sector of industry ‘IT, tourism, banking, private health care, etc. ‘ that has been the driving force behind Kerala’s economic growth spurt. While neither the manufacturing industry nor agriculture has experienced any significant growth over the past decade, the service sector now makes up something like 65% of the state economy, and has since 1986 until today gone from a growth rate of 3.25% to 7.5%. The remittances also probably served to underestimate Kerala’s economy throughout the financial dark ages, since they do not count directly towards the GDP. [Blomqvist 2006]



Obviously, the most common motivation to remit is simply that migrants care of those left behind: spouses, children, parents, and members of larger kinship and social circles. First of all, remittances may just ‘buy’ a wide range of services such as taking care of the migrant’s assets and relatives at home, with the likelihood and size of remittances depending on whether and when the migrant intends to return. Secondly, it is clear that migration is primarily (but not only) driven by wage differentials, implying that people are ready to incur substantial moving costs in order to access to international migration. [Rapoport and Docquier 2005]

The main results established in the literature are: remittances are motivated more by an altruistic motive than by an investment motive; remittances are counter-cyclical, i.e., higher under adverse economic outcomes in the native country; they are used more for consumption than for investment; and they do not respond much to relative rates of return on investment in the home country. [Gupta 2006] This result is supported by The Hindu Business Line which says that ‘Unlike the capital flows, interest rate differentials are not found to be significant in determining the workers remittances, thus underlining the stable nature of these flows.’


A trade off’

Migration to other countries take place mainly when there are better employment avenues abroad. This usually takes place after the individual has completed his education. Large scale migration has been criticized by imposing on them the ‘brain drain’ stamp.


Thus when migration takes place, the home country is losing a significant chunk of its educated labour force. In developing countries like India, there is much to be done; but since the addition to labour force happens at a faster rate than the increase in employment opportunities, this ‘migration’ tends to become inevitable.


A trade off is evident between ‘brain drain’ and ‘remittances’. Though ‘brain drain’ is said to have a considerable pressure on the home economy (By withdrawing educated labour force) remittances tend to improve standard of living in the home country. But usually remittances better the standard of living of the ‘dependent population’. They do not affect or increase the productive capacity of the Indian economy directly, but they affect it indirectly through increased consumption.


Illegal flows

Unofficial remittances are sent through friends or migrants themselves or through traditional networks, known in some countries as hawala or chiti, which allow money deposited with a trader in one country to be paid out by a partner in the recipient country. [Mutume 2005]


Hawala is an informal banking system in which funds are transferred internationally, without being moved physically. Hawala brokers, whose relationships are based in part on trust, maintain running accounts with one another. Once a sender deposits funds with a hawala broker, the broker contacts another hawala broker in the relevant location and requests the dispersal of funds to the recipient. Hawala brokers employ fast methods of communication, such as phone or fax. The main users of the hawala system reside in the developed world and transfer funds to recipients in the developing world. [Fugfugosh 2006]



The increased inflow of remittances is what is fuelling the ‘consumption boom’ in India. The fact that the SENSEX is bullish and the real estate markets are booming are proof to this. (There has not been any proportionate increase in the intrinsic values. They might be a bubble which is financed almost to a large extent by remittances.) Adequate studies should be targeted at such interrelationships between remittances and various markets in the home country, so that the small investors do not incur huge losses.


Since, these remittances are relatively stable, this consumption boom will tend to sustain for longer periods. Moreover, these remittances are said to be one of the main reasons for lowering poverty. For example, remittances enhanced the standard of living of the people in Kerala. They also contributed to development in African countries.


The government is trying to improve the investment benefits accruing to the expatriates with a hope of increasing the flow of remittances. There is no doubt that remittances are beneficial to the receiving country.


Recipients spend these funds (remittances) in various ways: for some, remittances are their lifeline, without which they do not eat, as in Somalia; for others, remittances are transferred home specifically to be invested in savings schemes with attractive incentives, as in India. In Cape Verde, migrant remittances contributed to political change of the oppressive island government while for people from other countries, remittances are directed to community infrastructure development, such as collective projects in Mexico. These illustrations convey the message that in all corners of the globe, remittances are a precious tool for every single recipient and that the secure flow of remittances must be assured. [Fugfugosh 2006]


Thus for countries like India where additions to employment opportunities take place at a slow pace, migration will take place. Providing better investment avenues for these expatriates will help, although not significantly in bettering the flow of remittances. Moreover, by making such inflows easy and transparent, the unofficial inflows will reduce. Targeting these remittances and channeling them to socially productive investment avenues such as education and health will improve the condition of the Indian populace.



1) Steady rise in NRI remittances, The Hindu Business Line, 29th January 2004.

2) The Economics of Migrants’ Remittances, Hillel Rapoport and Fr’d’ric Docquier, March 2005.

3) Welfare and banana leaf thalis ‘ a foreign student’s take on Kerala, Part 1, Olof Blomqvist, 2006.

4) Informal Remittance Flows and Their Implications for Global Security, Miriam Ahmed Fugfugosh, 2006.

5) Workers’ remittances: a boon to development, Gumisai Mutume, 2005.