Wages and Productivity

DS Wahid on the share of wages in GDP (excerpt):

Govt planning to push wages-GDP ratio to 40%

KUALA LUMPUR: The Government is planning to increase the ratio of wages to Gross Domestic Product (GDP) from 33.6% last year to 40% in the long term.

Minister in the Prime Minister’s De­p­artment Datuk Seri Abdul Wahid Omar said this would be done gradually.

“This is because any wage increase must be supported by increase in productivity,” he said after attending a media appreciation ceremony with the Statistics Department yesterday…

…Abdul Wahid said Malaysia’s CE percentage last year could be higher than Thailand’s and India’s but it was still much lower than the percentage of advanced countries of around 50%…

…Abdul Wahid said the country might not want to head in the 50% direction as it might lose its competitive edge.

A couple of things here.

First is the wage/productivity relationship. It really, really depends on which productivity measure you’re using. Intuitively, for most people this means wages should go up when you produce more, i.e. a 10% increase in wages when you produce 10% more widgets is deemed “fair”. To use productivity in its most general form, wages should increase more or less in tandem with revenue. This is of course, leaving totally aside any discussion of the distribution of those wages among labour.

But guess what? If you only increase wages in line with revenue, there’s no way for the CE/GDP ratio to rise. An equivalent increase in the return to labour for a given increase in the return to all factors of production (labour, financial capital, land, technology, whatever) results in….the same ratio for the return to labour. Therefore, for the CE/GDP ratio to increase, you must have wages increasing faster than productivity. Put another way, wage growth must exceed the rate of return to capital.

This is irrespective of whether the economy is growing or shrinking, or both wages and productivity are growing or shrinking. For the share of income going to labour to increase, the share of income going to every other factor must decrease. This is a distributional issue, not a growth issue. This is a change in the social contract, and not something you can achieve through growth alone – the “trickle down” effect does not work.

The second issue is that of wages and competitiveness. You can have low share of wages in national income and be competitive, or have a large wage share of income and be competitive. Both in theory and in practice, one does not necessarily preclude the other.

In this sense, productivity matters; but its the level of productivity that matters, not its growth. Finland is more competitive, but has the same wage share of income as much less competitive France. Germany has a lower wage share of GDP and is much more competitive than France, but also has a much higher wage share than even less competitive Greece.

I’ve looked at CE/GDP statistics (where they are available) across the globe – there seems to be no correlation with either productivity levels, income per capita levels or growth. CE/GDP does not appear to grow organically with higher incomes; for many economies, the ratio is fairly stable.

In instances where the CE/GDP has changed, there’s usually some structural factor at play – in Taiwan and Korea for instance, the biggest change (in the 1980s) was via a militant union movement. Malaysia’s recent changes appear to coincide with the introduction of the minimum wage.

So I have mixed feelings about having a 40% “target” for the CE/GDP ratio. While the goal of raising the wage share of income is something worth striving for, given the data, I don’t think limiting the ratio to 40% is meaningful – it doesn’t in any way define the competitiveness of the economy. Second, having a “target” in the first place might not be meaningful either, when the mechanisms by which the ratio is actually arrived at in other economies are so imperfectly understood – strike that, not understood at all.

That the ratio is rising at all is for me enough of a cause for celebration. But I won’t pretend to understand the whys and wherefores.