Tuesday, March 29, 2022

Minimum Wage Revised Part IV: Poor SMEs

I'm going to dive deeper into this topic, because there are a number of inter-related issues that need to be highlighted. The data here comes from the 2016 Economic Census, cross referenced with the subsidiary report on SMEs from the same survey.

Before jumping into how an RM1,500 minimum wage might impact SMEs, let me digress into a discussion of the nature of the capital share of GDP.

The 2020 split on the share of GDP was 37.2% labour and 60.1% capital (the residual is taxes and subsidies). This of course has given rise to accusations of greedy capitalists, which is (a little) unfair. Yes, the capital share in Malaysia is high by developed country standards, but its not out of line with other emerging markets. More importantly, the capital share is not the same thing as the share of income going to the business owner/shareholders.

Fundamentally, capital is a catch all term that includes income streams going to different capital owners. Capital actually takes many forms, all of which take their pound of flesh - depreciation (consumption of fixed assets) and amortisation (consumption of intangible assets), interest (loans), rent (land), and only finally, the return to the business owner. The government takes its share as well, through taxes. It's important to understand this, because actual returns to business vary widely between large and small businesses.

Here's the Economic Census data, including my estimate of the shareholder share after removing depreciation (I'm assuming straight line 20%) and taxes (using 2021 tax rates of 24% and 17%): 

I don't have a basis for allocating interest costs so this is not included here, while rent as far as I know is expensed out, so it should be included under input costs. Nevertheless, the capital share drops more than half after accounting for depreciation and taxes. This is still high at 23.7% - yes, capitalists are still greedy, but not as greedy as you might think from the capital share alone.

However, moving on to the topic at hand, the key point here is that there are substantial differences between large companies and SMEs, and within the SME space, between small and medium companies versus micro enterprises.

What you read about relatively poor SME productivity is true. Whether you look at revenue per worker or value added per worker, large companies have between 2.5x to 2.7x the productivity levels of SMEs as a whole. Medium size companies are more productive than small companies, and small companies are more productive than micro. The differential between large and micro enterprises is stark - 6.5x more revenue per worker, and 4.5x the value added. Shareholder share of value added for micro is just half that of large companies. More broadly, despite employing 22% of the workforce and paying 10% of the wage bill, micro industries only get 6% of total revenue. Labour costs are also a bigger portion of total costs, at 28.3% versus 11.3% for large, and 12.8% for medium corporations.

The impact of a minimum wage is therefore much more acute for micro industries since they would be the least resilient to a rise in wage costs, due to lower profit margins and proportionately higher labour costs. Having said that, for most sectors, profit margins are firm enough or the employment numbers are small enough, that pushing ahead with RM1,500 makes sense.

The exception to this is the services sector where profit margins of micro services are razor thin (4.5% excluding interest costs) and employment is significant (>20% of total employment):

My estimate of where average wages are now in micro industries overall is roughly RM1,400 (5% increase from 2015-2020, and flat thereafter). So RM1,500 might be just enough to wipe out business owners in services if they can't adjust their prices. And there are a lot of them - micro services form 70% of the total number of establishments. Micro agriculture also suffers from relatively low margins, but employment here is a miniscule 0.23%.

On that basis, the government's decision to defer implementation for micro industries has some merit. I think a phased approach might be called for here as well, balancing out the need for an increase versus arguments for business viability. The argument for small, medium, and large companies is however unequivocal, with an immediate increase to RM1,500 possible without significant aggregate employment effects.

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