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Confronting the thorny issue of the minimum wage

De Vos is a director with strategic consultancy QED Solutions.

As we approach the labour relations indaba to be hosted by Deputy President Cyril Ramaphosa, our focus will turn to the issue of determining a national minimum wage. In the lead up to the indaba, we can expect various interest groups, backed by all sorts of economic research, to support their predetermined positions on the matter.

One line of argument, something we see from Neil Coleman of Cosatu, is that imposing a minimum wage has no impact on unemployment and may indeed actually increase employment. This is backed up with research, analysis and examples from other countries such as Brazil.  None of these arguments present a convincing case.  This is not to say that there are no convincing arguments for a national minimum wage, but like everything in life, there are costs attached to the policy and we should examine who will bear those costs and their consequences.

It does not help the debate much when those opposing the minimum wage are likely to be mostly employers or earning salaries well above any proposed minimum wage.  How can this lot have anything to say about what it must be like to be a low-skilled employee with wages that are so dire that it is impossible to maintain any semblance of a decent life? How can they imagine the deprivation and the emotional drain of merely existing so that, over time, demoralization sets in to the point that one ceases to be even useful at the dead-end job itself? Whatever the merits of the arguments against the imposition of a meaningful minimum wage, they usually are made by those with an obvious self-serving agenda.

The problem with economics is that one cannot do controlled tests. Anything economists say about, say, the demand for labour in response to an increase in its price depends on ceteris paribus, or upon other things remaining equal. But in economics, you can’t do experiments in a lab. Ceteris never remains paribus in real life. If one points to the example of Brazil, where a minimum wage of sorts was implemented, one cannot ignore that Brazil’s economic growth over the past decade was as a result of a commodity boom driven by demand from China for just the types of commodities that Brazil has in abundance.  Strong economic growth will drive down unemployment and increase wages. Minimum wage rules won’t do it on its own.  In the same way, social grants (in Brazil’s case, the Bolsa Familia) funded by increased tax revenues from increased economic activity, will reduce inequality more effectively than a meaningful minimum wage might do.

Even measuring inequality in economics is hard to do and the way economists do this is not that helpful unless one really understands the measurement tool, the Gini coefficient that is often used –  including by economist Thomas Piketty. One can generate quite different results by grouping income bands differently.

Consider this, too:  South Africa has a large number of billionaires and our Gini coefficient would be reduced substantially if we could persuade just some of them (the Oppenheimers, the Ruperts, Christo Wiese and Patrice Motsepe) to emigrate.  A recent paper on Piketty using the economic history of South Africa and Sweden shows how Piketty’s methodology goes wrong. Looked at differently, if these billionaires were to emigrate, we would hardly be able to say that we have tackled the structural problems of inequality.  This does not mean that one can argue that we are not an unequal society. You don’t need a Gini coefficient reading – you only have to look out the window to know that.

In economics, almost anything can be countered with the now over-worked refrain that correlation does not imply causation. However, claiming increasing demand in the face of increasing prices goes against the basic rules of supply and demand. If such a claim is made, it calls for an explanation which falls into the domain of an exception to the rule. One example is Veblen goods (luxury items); the other might be under conditions of monopsony in which there is only a single buyer of low-wage labour (or a colluding band of buyers) that is able to set wages at a level workers cannot but accept.

Economic theory predicts that an increase in the minimum wage might increase both employment and efficiency.  It can’t be said that these exceptions to the basic supply and demand equation apply across the South African labour market. Stretching the case for minimum wages too far makes for ever-more complicated econometric analysis, as happened in the comments section of the Daily Maverick between Gilad Isaacs and Mike Schussler, neatly summed up here.

It is hard to exaggerate the dysfunction of South Africa’s labour market. By some estimates, over 8 million people are out of work or under-employed. According to Adcorp, labour’s share of national income is at a 50-year low largely due to precipitous falls in labour intensity due to the replacement of labour with mechanisation. Adcorp estimates that it takes 36,2% fewer workers to produce a given unit of output than it did in 1960. The impact of this has been felt overwhelmingly by the young and the less skilled.

A review of the empirical literature in the USA shows that minimum wages, if set above the market clearing price, have a disproportionate effect on less-skilled and younger workers. The finding there is that they reduce employment opportunities for less-skilled workers, especially those who are most directly affected by the minimum wage. In South Africa, as Jeremy Seekings, director of the Centre for Social Science Research at UCT, reminds us, every study finds that real wage increases reduce the demand for labour.

To some extent, we have had several dry runs at a minimum wage. A recent fascinating bit of research conducted by Nicoli Nattrass, a colleague of Jeremy Seekings at the Centre for Social Science Research,  shows how minimum wages have played a big part in driving many low-wage, more labour-intensive producers out of business. She makes the point that this is a tragedy for millions of unskilled, unemployed South Africans who would only able to find regular employment if South Africa had a more labour-intensive growth path.

It needs to be acknowledged, though, that the argument for the minimum wage is not just about labour market dynamics. Minimum wage legislation is not just popular here; it has a lot of political support around the globe. President Obama is seeking to shore up support for his Democratic Party by introducing new minimum wages in the USA.  It would be a far better debate, however, if there was an acknowledgement that although a minimum wage (at a level to sustain a decent life) will destroy the prospect that a good number of poor, unskilled and young will ever find permanent work, it may be a price worth paying to address inequality between those who do have a job.  This would require showing that the benefit to those who enjoy higher minimum wages will be greater than the cost suffered by those put out of work. But to do this, it will be necessary to show statistics and credible data to have an evidence-based approach.

We also need to look at the unintended consequences of a high minimum wage. Even if capital-labour substitution does not occur, it can change things imperceptibly. Employers can respond by substituting marginal workers (those targeted to benefit from the minimum wage) with higher-skilled ones who are attracted by the higher compensation on offer. Economists call this labour-labour substitution.

Perhaps the bigger concern for government is the growth of the informal sector. On one hand, the informal sector provides the only means for people out of work to survive. In a sense the informal economy is a monument to humanity’s will to survive – even under the most adverse circumstances. On the other hand, it exists in the shadows.  It operates outside the remit of any labour laws, arguably outside the remit of the Constitution, and, importantly for the government, it does not contribute much to the tax base.

A recent paper published by UCT’s Unilever Institute using field research conducted by the Sustainable Livelihoods Foundation shows that our informal sector is much larger than generally acknowledged.  This research shows that since the advent of democracy, the informal sector has grown twice as fast as the formal sector and might contributes as much as 6-7% to our GDP.  Because it is informal, this parallel economy is hard to measure. Whilst Statistics SA estimates economic activity in the informal sector to be at R120 billion per annum, Loane Sharp, chief economist at the Free Market Foundation, believes it to be much higher, at R680 billion per annum. The UCT Unilever Institute estimates it to be R280 billion, generated by as many as 1,2 million unrecorded enterprises around the country.

The debate on the size of the informal sector is an interesting one of its own, but whatever the position, as Loane Sharpe points out, high costs (whether labour or tax or any other regulations) in the formal sector push an increasing number of businesses into the informal sector.

It is hard to suggest alternative solutions. Clearly, inequality in South Africa generates high social costs, including crime, violence and dependency. This in turn poisons our politics and undermines the case for capitalism itself. The dilemma for those who support the minimum wage it that social justice demands a minimum wage higher than the economy is able to absorb. As such, a national minimum wage is being relied upon to do more than it able to do.

To a large extent, South Africa has already abandoned the path of labour-intensive growth followed by countries in Asia.  Whether we have a minimum wage or not, we should accept it is just not politically feasible to have growth on the back of sweat-shop conditions and we do not have the domestic savings to finance a capital-intensive growth path either.

The national minimum wage indaba will come and go, but we should be clear that it won’t solve the deeper structural problems in our economy that prevent us from growing out of our present troubles. In fact, it is best seen as a signal that our government has accepted that we will continue to chug along as we have done for so long, merely fiddling on the edges and thereby disappointing those optimists that continue to hope for a much better future for our country. DM

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