Inviting policymakers to an open-air beach party

Imagine inviting leading policymakersfrom all sides of the political spectrum to abeach party and asking them –How best to evade the social phenomena of a widening poverty trap? Certainly,we would expect them to express different views on the subject.

Those in government would immediately respond that the number of peoplein the lower income bracket is shrinking. In their opinion, there is no fear of a growing faction of social cases since the welfare net is generous in its outreach. The Opposition will raise the ante saying that in reality, our statistics are not finely tuned and may understate the true position,that of a widening net of people falling into poverty.Perhaps the two extreme views are seen to be widely apart and only an impartial economist can assess with accuracy whether the problem is acute or not.

For a start, we need to revisit how we calibrate a minimum wage to accurately compute the base wage bringing in the typical needs of a family by questioning the composition of the index used as a base for the cost of living adjustment (COLA) mechanism. Does this index truly compensate for changes in national productivity which is contributing to wealth creation(referred to as real GDP growth) and are the workers being adequately compensated to share in this surplus. Many may argue that the current €1.75 per week COLA adjustment has been eaten up by various inflationary measures such as increasesin the cost of bread, skyrocketing rents, higher fuel and medicine prices.

As can be expected, the Employers Association reminds us that increases in national wages have a detrimental effect on the competitiveness of our exports unless such increases are counterbalanced by higher productivity. Studies have shown that an increase in the minimum wage can have both positive and negative effects on the economy, adding that when the increase is modest, this generally contributes to a beneficial effect.

It is well known that an increase in the productivity of workers, as well as an increase in wages (boosting purchasing power)gravitatestowardshigher consumption. It goes without saying that any increase in the minimum wage should be motivated and quantified using objective economic measurements, further guided by dialogue with civil society and other social partners, and be “future proofed” so that it caters for any movement in inflation.

The obvious question to ask is: can employers afford to raise wages? The answer is a complex one since we know that most employers, particularly SMEs, cannot afford to pay higher wages. This is a dilemma. It leads us to ask what the best way for the State to intervene is. Through its various agencies, the State can devise a programme to help employers by supporting, especially,small to medium sized entities. As a classical solution,Malta Enterprise canprovide technical advice on how to improve productivity, employing innovative techniques and smarter marketing tactics. In short, as the business recovers it starts earning higher profits– thus able to afford paying better wages.

In practice, this bonanza is not easily achieved due to complex issues which hinder progress. This leaves our politicians arguing a lose-lose situation while the use of palliatives come in handy when COLA is announced. Let us examine in more detail recent studies on the social curse of a pervasive poverty trap. Caritas studied the plight of the poor in Malta in late 2012 and again in 2015. It found that the same basic basket of goods and services (no car, no foreign holidays; only the very basics) bought by a typical low-income family of two parents and two children cost €811 more than it did three years before. But in those three years, wages paid to lower income groups increased nowhere near €811 a year; weekly increases in fact consisted of 58c and two of €1.75,which add up to just €212 a year. It follows that those who were already at risk of poverty in 2012 sank deeper into poverty by 2015. Obviously, those who were just getting by are now in poverty.

What Caritas found was that the real cost of living of the lower income groups increased by 7.6 per cent over those three years, while government figures say that between late 2012 and late 2015 inflation was just two per cent. It is interesting to read an exercise published in the Economic Survey with the 2017 budget which announces that workers in the mediumand lower-income groups are not keeping up even with statutory retail price index, let alone real inflation. The IMF suggests redesigning the COLA mechanism to take account of productivity gains, rather than simply adjusting the weekly increase to match inflation.It argues that inequality is a threat to competitiveness since if workers lose purchasing power, the economy suffers.

On the other hand, seven years ago the EU commented that anupward adjustment to the minimum wage was hampering the competitiveness of the labour-intensive sectors. However, there is no certainty in the hypothesis that a minimum wage always creates unemployment: for example, this does not happen when the minimum wage is below the market wage.

Finally, most economists argue that there is no empirical evidence to show that wages and labour demand are negatively correlated: in most cases, and Malta is one of them, higher wages result in higher production and cause lower unemployment. However,a study by economist Lino Briguglio (published in 2014 with Melchior Vella) discovered thatan increase in the minimum wage could be offset by productivity growth, possibly leading to a reduction in unit costs. This effect, not mentioned in classical economic theories, is due to a number of factors that were not taken into account: for instance, well-paid workers are more willing to work so they are moreproductive. Moreover, well-paid workers will sustain the demand for the products they are producing. Threats to competitiveness arising from higher wages are popular among employers who produce in poor countries and sell in rich countries. But once rich markets are saturated, and labour costs are trimmed to keep up with competition this leads to a stagnating economy caused by an excess of supply: hence in Japan there wasfinancial instability and creeping deflationfor two decades.

Ideally, a middle of the road solution is linking the minimum wage to the average (or median) wage, or to the productivity, or to GDP growth. In conclusion, while policymakers at our hypothetical beach party are happily gorging food and imbibing chilled winethey do concur about the need to periodically align minimum wages and grant periodic increases to avoid enlarging the pool of people falling into the poverty trap. There was no consensus among our invited guests as to the perfect solution to combat poverty but all agreed that maintaining the status quo is not an option.