Tuesday, September 28, 2010

The Minimum Wage And Bargaining

Over the weekend, Dr Fong Chan Onn wrote a very long focus article in The Star with an interesting perspective on the minimum wage proposal, summing up most of the arguments for and against (emphasis added):

Should we set a minimum wage?

The issue of minimum wage for labour has been hotly debated since the advent of the industrial revolution in England in the 1760s.

Employers, using economic theories, argued that wages for labour should be determined by market forces – that is, the wage level at the interaction point of the supply and demand curves for labour. Any attempt at setting a minimum wage higher than that determined by the (assumed) efficient market, they argued, would lead to a distortion in the economy, and in fact would reduce employment opportunities for workers.

This argument held sway in industrial Europe for over a century.

But by 1824, Australia (Victoria) and New Zealand recognised that the labour market was imperfect and that employers would always have greater power in terms of setting wages. They enacted legislations to establish arbitration boards to set basic wages for industries that were deemed too lowly paid...

...In Asia, countries such as China, Indonesia, Thailand and Singapore have established national minimum wages or national wage councils, and as recently as in June this year, Hong Kong passed a law to set the minimum wage for its workers (at HK$ 28 or RM11.17 per hour)...

...Employers’ groups, led by the Malaysian Employers Federation (MEF), vehemently oppose any such move. Recently, they successfully lobbied for a delay in the implementation of the long overdue Wage Regulation Order for private security guards...

...The employers’ assertions, of course, assume that the Malay­sian labour market is efficient, with employers and employees in all sectors having equal bargaining power. This is obviously not true...

...Besides protection of workers’ welfare, the evolution of the world economy since 1970 has shown that minimum wage regulations have also become a set of tools that can enhance the progression of an economy towards high income status with social harmony...

...In light of dramatic improvements in labour management practices (which include minimum wages) the world over since the 1990s, it is imperative that Malaysia keep abreast and ahead of these practices so that we can continue to attract the new waves of FDIs.

These new FDIs (such as the Apple supply-chain entrepreneurs) are now looking at not only economic but also labour issues as part of their relocation criteria.

...In a nutshell, I believe the smoothest way to introduce a minimum wage system in Malaysia is to amend the Wages Council Act, as well as the Sabah and Sarawak Labour Ordinances, for the establishment of a National Wage Council for Peninsular, and State Wage Councils for Sabah and Sarawak...

...Even with a minimum wage system, employers will still have the edge over the bargaining power of workers. What the system will achieve, however, is to set a floor wage upon which Malaysian workers are assured of a decent subsistence living.

Higher wages would drive companies to use labour more efficiently and introduce mechanisms to achieve higher productivities, including multi-tasking for workers.

Hiring of part-timers would be more common. College students and retirees working part-time in restaurants, so common in advanced societies, will also become a common sight here. This will benefit the country both socially and economically, through the utilisation of this currently untapped talent pool. But job opportunities for full-timers could be reduced consequentially.

The government has also to ensure that the minimum wage system is effectively implemented. Its implementation will be clearly hampered if we do not address the issue of the 2.5 million foreign workers in the country.

International norms dictate that they should also be entitled to the minimum wages. Hence, we will have to be more restrictive on the inflow of foreign workers.

But with the higher wage levels, more local workers will be enticed (from Singapore) to join sectors they previously shunned. Employers will thus have more opportunities to replace foreign workers with better-trained local workers.

Another issue that minimum wage does not resolve is graduate unemployment.

The source of this problem is due to a mismatch of talents and qualifications with market demands. Local universities should quickly address this issue, otherwise with higher wages, there would be even greater competition for graduates in the job market, thus aggrieving the graduate unemployment issue.

Another worry is that employers will impute the higher wages into their costs of production and attempt to pass these additional costs to consumers.

Here, the UK experience can help. The British government, after introducing minimum wages, also amended the laws to make the British labour market more flexible, with greater ease of hiring and firing of workers, but cushioned by a more extensive unemployment assistance scheme.

Malaysian employers should, therefore, lobby for greater flexibility of the labour market under the minimum wage environment.

Many other earlier developing countries (such as Korea and Singapore) have achieved high income status by learning from the British experience of the 1990s, that is, transforming their labour markets to admit the working class into middle class.

Our educational and other social institutions are now ready for a similar transformation. The implementation of a minimum wage system will accelerate this process.

When every Malaysian worker is embraced as a member of the middle class and part of the Middle Malaysia, there will be no poor Malay, Chinese or Indian worker. We will become a high income economy in which everyone will have a greater stake to preserve and enhance our social harmony

He is probably right regarding the relative bargaining power between employers and workers – micro was never my strongpoint, but it rings true. And his points regarding what should be done in conjunction with the implementation of a minimum wage dovetails with my own ideas recently, though I’m thinking of the labour market in general rather than specifically with a minimum wage – we need a stronger welfare mechanism to take care of displaced workers (which I regard as inevitable with the ETP), and we also need a more flexible labour market that includes support for part-timers.

But I disagree that the presence of a minimum wage would help attract FDI. For one, my position has been that it is not FDI that is an issue, but rather investment in Malaysia generally. Secondly, I fail to see how raising floor wages will be attractive to foreign investors, especially those in high value-added industries – shouldn’t it be the other way around? And a more flexible labour market increases employer bargaining power, which acts directly against the point Dr Fong is trying to make.

I’m also at a loss to see how a minimum wage can be used to “transform” the working class into the middle class – a minimum wage puts a floor for the very lowest paid, not for low-paid workers generally. Second, my belief (and I can’t back this up with hard data yet) is that the minimum wage will primarily affect foreign labour in Malaysia, and not necessarily Malaysians (pace plantation workers).

I note in passing that Dr Fong completely brushes aside the issue of a minimum wage creating unemployment for marginal workers.

One last point to make is that employers passing through costs to consumers is, to me, one of the vital mechanisms with which to ensure Malaysia’s transformation into a high income economy.

There are two countervailing issues here – one shows why the cost increase is necessary, and the other shows why it won’t matter.

To attract and sustain private investment, whether foreign or domestic, you must be able to maintain returns to capital. That’s why a flexible labour market is so important – not because it reduces labour costs (it doesn’t), but because you can more easily fire unproductive workers and replace them with more productive ones. But in that event, the cost pass-through is still necessary to redress the balance between labour income and returns to capital, while still maintaining the latter.

Second, what we’ll see is an evolution in the CPI. Even with labour cost pass through, I don’t think we’ll see a secular rise in headline inflation. What we will see is different trends in the components of the CPI, with goods inflation slowing or going in reverse (clothing & footwear, beverages, furnishings/household, possibly food), but services inflation rising rapidly (education, health, recreation, restaurants and hotels). Overall, it ought to be a wash, especially since higher incomes and a shift towards the domestic services sector also induces an appreciation in the exchange rate (making imports of goods cheaper).

The mechanism for this evolution is simple: industries with a high labour input component (e.g. services) will have a higher labour-cost pass through. Take the plantation sector example that Dr Fong uses. Despite employer preference for low-cost labour, the biggest cost input into primary palm oil production isn’t labour, it’s fertilisers. Mechanisation isn’t a simple affair either, as this article shows.

So all in all, while I’m sympathetic to the potential welfare benefits of a minimum wage (and mindful of its costs), I can’t subscribe to its transformational capabilities.

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