There has been extensive debate on the national minimum wage (NMW) and the expert panel’s recommendations. A recent exchange in Business Day in which the chairman of the panel, Prof Imraan Valodia, responded to Ann Bernstein has been particularly revealing about the reasoning underlying the panel’s recommendations.
Valodia draws a sharp distinction between the market for labour and the market for tomatoes, arguing that in the case of tomatoes the only feasible adjustment consequent upon an increase in price is a reduction in demand. However, by contrast, in the case of labour "all sorts of adjustments are possible — productivity could increase, profit rates could fall and domestic demand could rise".
It is these adjustments that, in the view of Valodia and the panel, could compensate for the potential negative effect of the introduction of a NMW on employment.
However, as Valodia’s correct use of the word "could" suggests, these adjustments might not occur, and even if they do, they could have negative as opposed to positive consequences for employment and growth.
Consider each of Valodia’s hoped-for positive adjustments:
Productivity could increase. Low-wage employers affected by the NMW are, indeed, likely to try and increase productivity, because if they do not do so, they will go out of business. The key issue is what this means for jobs.
Our research indicates labour-intensive clothing firms are making plans to shed their last remaining unskilled workers, for example, by purchasing trimming machines to replace their trimmers (workers who cut loose thread off the finished garments). They are also purchasing mechanical floor cleaners and planning to retrench sweepers. In the construction industry, manual work is being replaced by machinery (notably mechanical diggers) and this is likely to increase. Security companies are replacing guards on the ground with centrally monitored cameras (some of which can now be monitored by computers).
Higher minimum wages prompt employers to shed low-wage, low-skilled jobs, thereby keeping only those with "decent work" (jobs with higher productivity and higher pay) such as machinists and bricklayers. This comes at the cost of destroying the last remaining jobs for SA’s army of relatively unskilled, unemployed people.
The panel accepted that the introduction of a NMW at a level of R3,500 a month could cause job losses (and reductions in working hours) in domestic work and agriculture. This is why they allowed for subminimums and a longer implementation period for these sectors. The panel assumed that "there is limited scope for labour-productivity improvements to accommodate higher wages" in these sectors, hence the temporary exception. However, even in these sectors, productivity growth is possible through mechanisation. In the next few years farmers are likely to switch to less labour-intensive crops and reorganise their fields, orchards and vineyards to facilitate additional mechanised harvesting. Domestic workers are also vulnerable to having their hours reduced and to possible reductions in their take-home pay.
The panel provides no reasons why it granted a temporary exemption to such low-wage, labour-intensive sectors rather than a permanent exemption — nor why the exemption was not granted to other low-wage labour-intensive sectors. Was this to keep the fiction alive that SA can afford a single NMW rather than the current system, which sets minimum wages for each sector, after taking account of their specific circumstances?
Profit rates could fall. If firms are earning excess profits, they might respond to higher minimum wages by accepting lower profits rather than shedding jobs. However, most labour-intensive sectors have low barriers to entry, are highly competitive and, accordingly, have very low profit margins — the labour-intensive clothing industry for example. There is thus very little space for profits to be squeezed further, and so the consequences of a higher minimum wage will be felt in terms of job losses and slower job creation as these labour-intensive firms adjust by becoming more capital-intensive or leaving the sector.
Where firms can tolerate lower profits, there will be fewer job losses. However, lower profits have other adverse economic effects such as lower savings and investment. Lower profits also result in lower tax receipts, and hence, lost opportunities for the government to redistribute income in other ways, for example through social assistance. Lower tax receipts will also result in a reduction in government services and associated employment.
Domestic demand could rise. Higher minimum wages can, theoretically, increase domestic demand (total spending in the economy) because low-wage workers spend most of what they earn. If – and this is a very big if – the benefits to firms of this increased demand outweigh the costs of higher wages, employment could increase. Such "wage-led growth" is possible, but it involves taking a huge bet on the relationship between wages, demand and output. In SA, higher demand encourages more imports (meaning some of the benefits of higher wages leak out of the economy), making the country more dependent on foreign inflows of capital. SA’s constraints are on the supply side, not the demand side.
Where firms cannot adjust to higher wages through productivity improvements, reduced profits or increased output to meet rising domestic demand, they will be either forced to raise their prices or to go out of business. Higher prices drive inflation (reducing real earnings of workers) and make South African exports less competitive, thereby further threatening employment and growth.
All the adjustment factors in which Valodia and the panel put their faith, which "could" increase employment, "could" also have a much more muted, neutral or even quite opposite effect, reducing employment and growth.
More importantly, irrespective of whether there are immediate direct job losses, setting a wage floor of R3,500 a month will make SA’s overall growth path ever more capital intensive.
Fewer jobs will be created per unit of capital invested, which will make reducing unemployment exponentially more difficult over time.
Less attractive
New firms will avoid labour-intensive sectors and activities. The minimum wage will damp the creation of new small and medium enterprises because these tend to be more labour-intensive than larger, established firms.
Worse still is the negative effect on labour-intensive exports. Millions of jobs are leaving China because the labour market there is very tight: unemployment is low and wages are rising. SA could attract some of these jobs.
A minimum wage of R3,500 makes SA a far less attractive location for labour-intensive export manufacturing.
SA needs to raise the "employment elasticity of growth" (to increase the rate at which economic growth creates jobs), not to reduce it further than its current low level, otherwise SA will be in the position where any significant formal job-creation requires a steady expansion of wage subsidies, with the taxpayer picking up much of the cost of higher wages for less-skilled workers.
Valodia states the panel looked at all the models, "took a balanced view" and that the "panel’s proposals are balanced". Despite this emphasis on balance, the expert panel rejected the models of the Treasury and the Development Policy Research Unit of the University of Cape Town, both of which projected substantial job losses for a minimum wage of R3,500. By contrast, the panel accepted an unpublished demand-led economic model, which, as Valodia makes clear, predicted the minimum wage would have no negative effects on employment and would simultaneously stimulate growth. This win-win scenario appears to assume that all Valodia’s positive adjustments will take place without any of the downsides discussed above.
A minimum wage of R3,500 makes SA a far less attractive location for labour-intensive export manufacturing
— MINIMUM WAGE
Neither Valodia nor the panel have yet provided any substantive arguments about why they accepted this model.
Since the heart of the debate concerns the likely economy-wide adjustments consequent upon the introduction of the NMW, it would be interesting to hear the view of macroeconomists who, thus far, have not participated in this important debate.
The possibility of job losses in the short-to medium-term and the costs of rising capital intensity and a lower employment elasticity of growth in future must be confronted.
If economic growth picks up over the following years, modest employment growth can be expected. But more than modest employment growth is needed to deal with SA’s unemployment crisis.
A growth path is needed that is more labour-absorbing, in which for every unit of growth more jobs are generated.
The debate needed over the introduction of a NMW is about its implications for the growth path and for the employment creation pace.
• Kaplan and Nattrass are professors in the University of Cape Town’s School of Economics
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