Minimum Wage Review

It’s been two years since the implementation of Malaysia’s minimum wage policy, and it’s now up for review (excerpt):

Review on minimum wage policy

THE minimum wage policy is up for a scheduled review this year and the trade unions are asking the Government to increase the current floor of RM900 a month by 30% to RM1,200….

…Minister in the Prime Minister’s De­p­artment Datuk Seri Abdul Wahid Omar said in September last year that the Government is loooking at gradually increasing the ratio of wages to gross domestic product (GDP) from 33.6% in 2013 to 40% in the long term.

“There is a need for intervention in order to push the ratio of compensation for workers to GDP,’’ Malaysian Institute of Economic Research (Mier) executive director Dr Zakariah Abdul Rashid said….

…He said the ratio of compensation for employees (CE) to GDP is very low in Malaysia, implying that workers are not getting a fairer share in economic development of the country.

Countries that have moderate of about 40% CE ratio are Taiwan 46.2% and South Korea 43.7%. While developed countries generally have high CE ratio of about 50% such as the US 52.8%, Japan 51.9% and Germany 51.5%.

Zakariah said although salaries in Malaysia have rise[n] over time, but the growth is rather flat and somehow it does not reflected[sic] the country’s productivity gains. In order to catch up to the 40% CE-to-GDP target it would need to see salaries and remuneration growing at a faster rate than revenue.

Personally, I think raising the minimum wage to RM1,200 might be excessive. The standard rule of thumb is 40% of average (or even median) wages. That means Malaysia’s minimum wage is about right where it should be. Of course, that presupposes that the average wage is actually high enough for a decent standard of living and relative to productivity. Which leads me to the next section:

It’s a common belief that wage increases should be preceded by increases in productivity. The idea comes from the original economic growth models, which assumed that inputs were paid their marginal productivity. This assumption, which appeared to be supported by empirical evidence back then, in turn morphed into the idea that returns on factors of production and productivity were inextricably linked, and rewards to inputs were what was “deserved” by each. In turn, this led to the idea that for wages to rise, you must increase labour productivity.

The global experience of the last 30 years suggests that’s not true – returns to inputs and productivity can and does diverge, or to be more precise, are not necessarily static. A cross country comparison certainly suggests that there’s more than a direct link – wage shares of national income vary considerably, even among countries with similar levels of productivity.

The second problem with the conventional wisdom is that it’s a partial equilibrium approach – the whole “raising wages before increasing productivity leading to higher inflation” argument presupposes that the rates of return on other inputs are held constant. Again, not necessarily true – raising productivity before raising wages means effectively raising the rate of return on capital first. Nothing in economic theory suggests that capital should have first dibs on the gains from increased productivity.

Apropos to the above, I came across this summary of research on wages and productivity last week from the Peterson Institute for International Economics:

Higher Wages for Low-Income Workers Lead to Higher Productivity

Under what circumstances can raising the pay of low-skilled workers at large corporations lead to general improvements in productivity? Last month, Aetna informed the Institute of its plan to raise wages of its lower-paid workers. With this natural experiment in mind, Justin Wolfers and Jan Zilinsky decided to explore literature and theory on how pay increases influence productivity. The following note summarizes their findings for major private-sector companies in the United States in general (and does not address the implications for Aetna itself or for any specific company or sector).

Economists have long argued that increases in worker pay can lead to improvements in productivity—indeed, that it can actually be profitable to pay workers higher wages. As Alfred Marshall, the father of modern economics, argued almost 125 years ago, “any change in the distribution of wealth which gives more to the wage receivers and less to the capitalists is likely, other things being equal, to hasten the increase of material production.” Since then, economists have compiled rich data validating Marshall’s hypothesis that paying higher wages generates savings.

Here’s a summary of the summary:

1. Higher wages motivate employees to work harder
2. Higher wages attract more capable and productive workers
3. Higher wages lead to lower turnover, reducing the costs of hiring and training new workers
4. Higher wages enhance quality and customer service
5. Higher wages reduce disciplinary problems and absenteeism
6. Firms with higher wages need to devote fewer resources to monitoring
7. Workers excessively concerned about income security perform less well at work

There’s research papers backing all the above (more or less). But I think one way to persuade employers that raising the minimum wage might be a good idea is to quantify the costs associated with higher staff turnover and low productivity.