In March 2024, the Cabinet approved a 40 percent increase in the national minimum wage level to support the low-income earners who have fallen into poverty due to the economic crisis. Can this pay hike truly help the poor and reduce inequalities in the future? An important question at the moment. 

The debate over minimum wage has been ongoing, with one side arguing that the wage increases might reduce employment, while the other emphasising the positive impact on the living standards of the poor. However, numerous economic studies have shown that the minimum wages have little to do with or no effect at all on employment. Against this backdrop, the International Labour Organisation (ILO) notes that, appropriately set minimum wages could reduce inequality and benefit the poor, depending on the country-specific economic situation. Accordingly, we focus on assessing the potential effectiveness of Sri Lanka’s proposed minimum wage hike, using the Labour Force Survey (LFS) 2022 data.

The ILO’s Global Wage Report 2020-21 highlights that the effectiveness of a minimum wage depends on three key factors: legal coverage and compliance, the level at which it is set and the characteristics of the beneficiaries. To effectively reduce inequality and support the poor, the minimum wage must have a broader coverage and compliance, be set at an adequate level that considers workers’ needs and the country’s economic conditions and target beneficiaries at the lower end of the income distribution.

Non-compliance

In many developing countries, wage workers’ earnings less than the minimum wage are either not legally covered or face non-compliance issues. However, there are no exceptions to legal coverage in Sri Lanka, as all employees in any industry or service are protected under the National Minimum Wage of Workers Act, No. 3 of 2016, which prohibits employers from paying below the national minimum wage. So, why do some workers still earn less? This is due to high levels of non-compliance, largely because over 60 percent of employment in Sri Lanka is informal. 
According to the National Minimum Wage of Workers Act, 2016, for employees paid daily, the minimum wage was Rs.400 per day, while for those on a monthly wage, it was Rs.10,000 per month. This was first amended in 2021, increasing to Rs.12,500 for the monthly wage workers and Rs.500 for the daily wage workers. In 2022, despite the wage increase in 2021, the LFS data displays that many workers still earned below the minimum wage, in both formal and informal sectors with a significant portion being from informal employment. This is approximately 97 percent among the daily wage workers and 80 percent among the monthly wage workers. 

The informal workers are not protected under the legal and regulatory frameworks, resulting in pay below the minimum wage and poor working conditions. Thus, a minimum wage hike in Sri Lanka risks being ineffective unless accompanied by efforts to encourage formalisation. Even worse, further analysis by occupation reveals that some formal workers too yet earn below the minimum wage. 

Among the employees earning below the minimum wages (excluding any other compensations), the formal sector accounts for a greater share in managerial, professional and clerical worker categories than the informal sectors. In contrast, the informal sector accounts for a greater share in technical, service and trade, agriculture, craft, machine operating and elementary occupational categories than in the formal sectors. These findings demand for the implementation of effective measures to ensure compliance following the recent minimum wage hike, unlike in the past.

Lack of timely adjustments 

The effectiveness of the minimum wage depends on the level at which it is set, while deciding the optimal level is a challenging task. The ILO emphasises that the national minimum wages set at less than half the median wage would leave many workers with low pay, which was the case in Sri Lanka, according to the 2022 data. Therefore, the 40 percent increase to the existing minimum wage of Rs.12,500 is a sound decision, bringing it slightly above half the median wage of Rs.32,000. Further, increasing it towards the median wage is impractical, as it would require raising wages for half of all employed workers, likely resulting in disemployment effects with high non-compliance.

Besides, in Sri Lanka, the minimum wage has long been ineffective due to the lack of timely adjustments, resulting in stagnant nominal wages. According to the ILO’s Global Wage Report 2020-21, globally, 114 out of 153 countries saw growth in minimum wages in real term between 2010 and 2019. 

However, in Sri Lanka, the real value of the minimum wage has declined since 2016. By the end of 2022, the minimum wage in Sri Lanka was too low relative to the economic factors, exacerbated by the country’s economic crisis, which led to unprecedented poverty and inflation. In this context, it is commendable that the government decided to raise the minimum wage to meet the poverty line, as it had fallen below the poverty line since July 2022. 

For the minimum wage to remain effective and meet the employee needs, however, timely future adjustments are necessary. This is confirmed by the behaviour of nominal and real minimum wages during 2016-2024 against the country’s poverty line.

Beneficiaries

It is important to assess whether the workers earning less than the minimum wage are from the poorest households or better-off families. In Sri Lanka, most workers (80 percent of the daily and 68 percent of the monthly earners) who earn below the minimum wage and work over 40 hours per week are from families earning below the median family income. This indicates that the minimum wage is effectively targeting the lower end of the wage distribution, showing the potential to reduce inequality. 

These workers are predominantly in elementary occupations also with significant numbers among machine operators, service and sales workers and craft workers. Many have temporary or casual contracts and some are without a permanent employer. The majority are in the services and industry sectors as many in agriculture, who earn less, are self-employed in the informal economy or unpaid family workers. 

Furthermore, an effective minimum wage can help close gaps between demographic groups if properly targeted. Most workers earning below the minimum wage, working over 40 hours per week, are from rural and estate sectors with education below A/Levels and are over 30 years old, suggesting they likely have families to support. The share of women is lower than men due to higher male labour force participation. However, the share of women earning below the minimum wage compared to its total is higher than that of men. Thus, the minimum wage in Sri Lanka appears to be well-targeted in reducing the gaps between different groups.

What needs to be done?

Since Sri Lanka’s Minimum Wage Act legally covers all employees and effectively targets beneficiaries to reduce inequalities and support the poor, the next steps should focus on promoting compliance and reducing high prevalence of informality in employment. This includes creating opportunities to enhance worker productivity and increase wage employment. Additionally, it is essential to implement regular and timely adjustments to the minimum wage based on a balanced and evidence-based approach that includes all social partners: employees, employers and socioeconomic advisors, reflecting changes in the cost of living and other economic conditions. 
While maintaining the minimum wage at an optimal level to limit employment effects, it is important to ensure that it is not too low compared to the living wage, which covers the basic necessities like food, clothing, childcare, housing, health insurance and transportation. Otherwise, it will be challenging to provide decent living standards for many workers. Therefore, a social dialogue around minimum wage rates should be grounded in solid, country-specific evidence that considers the needs of workers and their families, alongside national economic factors such as productivity, prices and employers’ capacity to pay while maintaining employment levels.

(Nilupulee Rathnayake is a Senior Research Professional working under the livelihoods and employment thematic at the Centre for Poverty Analysis (CEPA), Colombo. She holds an MSc in Development Economics from the University of Nottingham and a BA in Economics from the University of Colombo.)