Dramatic change to pay structure will set off dangerous chain reaction

Advisory panel is willing to run the risk of job losses but has understated the likelihood and potential number

This week, SA’s “social partners” agreed to a framework for the implementation of a national minimum wage. This reflects the recommendations of a panel appointed in 2016 to advise Deputy President Cyril Ramaphosa, which proposed a minimum hourly wage of R20, the equivalent of R3,500 a month.

Though the panel pretends otherwise, its proposal is a high-stakes wager with the livelihoods of tens or even hundreds of thousands in play. It is a wager that is being made in a stagnating economy in which nearly 40% of the potential workforce is unemployed.

There is little doubt that the South African economy needs game-changing interventions to achieve the growth we need. What is needed most urgently is a strategy to return the economy to more rapid, more inclusive growth. The panel’s proposals are far more likely to undermine this goal than to advance it. They are likely to deepen poverty and inequality by destroying existing jobs and reducing even further the demand for unskilled labour.

By their own lights, the panel’s proposal is a big deal: it estimates that 47% of all workers (or 6.2-million people) earn less than R3,500 a month, a proportion that rises to about 90% in agricultural and domestic work. The recommendation is so dramatic a break from existing pay structures that the panel’s proposed minimum wage exceeds the average wage in a number of industries.

The radical scale of the proposed changes is, of course, their very point: the panel hopes to effect a significant upward shift in pay at the bottom of the pay scale precisely because it wants to reduce the rate of working poverty. What, however, of the effects on employment, especially when unemployment is the principal driver of poverty and inequality?

The panel acknowledges risks to employment from a national minimum wage that is set above “affordability levels”. This is the key reason for its proposed exemptions and for the delayed implementation in sectors in which wages for large numbers of workers are particularly low. It also acknowledges submissions from the Development Policy Research Unit (at the University of Cape Town) and the Treasury, which estimate job losses of between 200,000 and 1-million from a national minimum wage of R3,500pm.

The possibility that these negative outcomes might arise is acknowledged. But the panel is willing to run these risks, presenting the merest hint of a justification for betting against them when it says, as it does more than once, that the international experience shows that the risk of job destruction is “often overstated”.

But how relevant is the international experience to the panel’s proposals? Not very.

The first reason for saying this is the sheer scale of the potential effect of the panel’s recommendations on the cost of labour in SA, where almost half of all workers who do have jobs earn less than the proposed minimum.

The second is that the proposal is being made in the context of an economy that already generates far too little demand for unskilled labour; an economy in which the high unemployment rate shows that millions of people are willing to work at existing wages but simply can’t find a job. Neither of these two facts is true of any of the other countries in which minimum wages have been implemented. On the contrary, minimum wages are generally implemented or raised only when the labour market is relatively tight, which limits the likelihood of job losses. Most minimum wage regimes are carefully designed and implemented so as to ensure that they do not lead to large-scale job destruction.

So if fears about job losses are sometimes overstated, this may have less to do with the effect in principle of minimum wages on firms and more to do with the care policy makers have taken in designing their interventions. To draw general lessons from this and to apply them where a much more radical set of changes is being proposed is a dangerous mistake. Indeed, in its estimation of the effect of its proposals on employment, it is the panel that has erred: it has understated both the likelihood that jobs will be lost and the number of potential job losses.

One way to tell whether a national minimum wage that is considerably higher than existing wages would lead to job losses is to ask oneself whether it is plausible to argue simultaneously – as the panel does – that a high national minimum wage would make a big difference to the welfare of households and yet make no difference to the performance of firms paying those higher wages. This cannot be: if the national minimum wage produces material benefits for large numbers of households, there must be some set of people who pay for those benefits. While Keynesian stimulus may work in the short term, a structural break of this kind is not a free lunch.

But who, exactly, would pay for the national minimum wage? This is a question that the panel does not answer explicitly, and different answers bubble through different parts of its report. One answer is that firms will find productivity improvements; another is that firms will accept lower profit or will pay their better-paid staff less.

A possibility that does not appear to have been considered by the panel is that some firms will raise prices. This will be especially common among firms that face no foreign competition, such as builders, retailers and taxi owners. This would mean that some of the benefits enjoyed by those whose wages rise will be paid by those whose incomes do not. This population includes both the rich and the far more numerous poor.

So, one likely effect of the national minimum wage is higher prices, which means reductions in living standards, with real consequences for levels of poverty in households in which no one works or in which incomes do not rise.

CAPITAL INTENSITY

Higher prices are only one mechanism through which a national minimum wage can increase poverty. The more significant one is through job destruction, both in the short term (as some firms downsize or close) and over the medium and long term, as firms rethink their products and production techniques in order to economise on the use of unskilled labour.

Strangely, the possibility that raising the minimum wage will affect the way firms plan their growth and the degree to which this growth absorbs unskilled labour appears barely to have featured in the panel’s thinking about the minimum wage. This is despite clear evidence that a key driver of rising unemployment over the past few decades is the increasing skill intensity and capital intensity of the SA economy.

In fact, matters are worse than this: to the extent that the report reflects consideration of this critical issue, it appears as if the panel has a positive preference for firms to find higher productivity — in other words less labour-intensive — approaches to producing their goods and services. The report sees higher productivity as the vehicle through which firms will afford higher wages.

The problem with this is that raising worker productivity literally means that fewer workers produce the same amount of output. Calling for firms to increase worker productivity in response to higher wages is, therefore, the functional equivalent of asking them to find ways to make do with fewer workers.

Given our astonishingly high levels of unemployment, to advocate a policy that will push firms to reduce their demand for unskilled labour seems perverse.

The national minimum wage also carries dangers of unintended macroeconomic consequences. To the extent that a high national minimum wage reduces employment, it is very likely to reduce aggregate demand and GDP (though any increase in productivity will offset some of this). This is the opposite of what proponents of the national minimum wage claim, but the conditions in which it could lead to growth are so restrictive and unrealistic as to be laughable.

Much more likely are job losses leading to lower growth. And any reduction in GDP, or in its rate of growth, is likely to mean higher interest rates and lower tax revenue, making it far harder for the government to pay for the redistributive programmes it already undertakes, thus deepening poverty. The government would also not be able to afford the many investments in human and physical capital needed for faster economic growth.

The balance of risk is that a high national minimum wage would increase rather than diminish our exceptionally high levels of poverty and inequality through job destruction in the short term and reduced labour absorption over the long term; possible reductions in GDP growth leading to lower per capita GDP; less redistribution through the fiscus; and higher inflation.

The key question to ask is whether a country in SA’s position, with one of the highest unemployment levels in the world, – can afford to play Russian roulette in this way.