Wage hike and its implication

“I would like to, first of all, declare that I have no political agenda, no political incentive or whatsoever to write any article in favour of any politician. This is democracy, and I live under freedom of speech. I believe it is my right to voice out my opinions, under the laws as the binding force, (as long as they cause no harm or damage towards the others) should I choose to. Anyone who scorns, threatens and ridicules anyone else (for expressing his/her opinion) on groundless rationale shall never call him/herself pro-democracy.”

Regardless, wage raising does not have anything to do with politics in the first place. Those people just use it as a means to achieve their ends. Balancing wage and growth is all about Economics, pure economics I say.

To start off, understanding the nature of economics is crucial. People are delighted by good intention and promising ends/goals. However, living in an ideal world is a blindness, not to mention choosing to do it perversely. Reality is full of suffering, but by accepting reality, we can at least suffer and move forward having a chance to find an oasis. It is much better than playing pretense. You have to understand that in this world, perfection does not exist. You cannot expect a good life without a tradeoff. It does not work this way. Nothing is free because everything entails a cost. The right question to ask is what is the cost of this or that particular decision? At what cost is the decision to indulge the entire economy in a short-term prosperity, something you deem righteous and just?

A simple and naive mind would look at the economic systems and policies and sees only the goals they pursue. Economics, however, is more about the incentive those decisions create. In other words, the consequences are the main concern, not the intention. A good intention, the act of philanthropy, that will cause ruinous damage later on is nothing but evil. Despite the fact that it is done out of love, feeding your kids McDonald everyday until they become fat kids is not a good thing, is it? No, I do not think so. Of course, they might be enjoying this special treat everyday until it becomes an addiction, a sickness of the mind. But how long will it last? How long will it take until they realize that obesity will strike them in the face as they become teenagers/adults. Economic systems and policies are no different. Some policies look desirable, and it might yield a favorable outcome in the short-term, but just before you know it, it will become a disease, a long-term adversity to our economy.

All else constant, wage raising is not negative per se. Wage raising is good when the economy is growing because it will offset the inflation effect (rising price) and at the same time, synchronize with the rising productivity. Increasing wage will increase the standard of living, and as people with higher income are likely to spend more (demand more), it allows no excess in the market economy, increases demand for more goods and services, creates more jobs, more houses… more stuffs (long-term prosperity you are witnessing here!). It will also enable shifting to a middle-class society where a majority of people live with sufficient income to serve their basic needs and afford amenities of life. They will probably still have some saving which will turn into investment either directly or indirectly via loan.

However, a joke (about monkey stealing people’s pants) that seems to be hilarious during your happy family dinner time might have a different taste and outcome when you tell it to your boss whose pants have just been stolen by a monkey (and are now pantless). He would be quite upset I suppose, and you might be sacked. The economy is no different. A once seemingly great policy (wage raise) when the economy is shooting up might cause a major crisis when implementing it under different circumstances, not limiting to a depressed economy.

Now I will give you an example, a scenario in which wage raising, or should I say “wage hike”, is most likely a regrettable decision. That is to say, a change is okay, but a drastic change is not. Assuming you have a least-developed country, Poorland, whose garment industry is one of its economic backbones. First, we must define “garment industry”. Garment industry, as far as I know, has always been a low-wage industry, and to say any differently is opposing reality. But does that mean that it should stay this way forever? No. However, an abrupt wage hike without any understanding the possible repercussions is not the right approach either.

As defined, garment industry, by today’s standard, is a low-wage industry. The human-to-machine ratio is not that great, and thus, the productivity is mostly limited to the innate capability of human. After all, the garment industry is a labour intensive one by nature. What does this tell us? This tells us that a wage hike in Poorland will significantly lower its competitiveness in this specific sector compared to other countries. So the first apparent effect is the movement of garment industries from Poorland to countries with lower wages. Second, garment exports will also decrease sharply which will hurt the national economy. So the people are the ones to suffer when we lose more and more jobs.

Another impact is the inability of the garment industry to hire mass labor as it used to. I am assuming that each factory’s owner is a profit-seeking individual (which is a rational way to look at it). So this will compels them to layoff some workers, and keep and employ only the best they could find. Those whose skills and productivity are relatively low will be dismissed. They can also retain every worker, but they might have to raise price and cut back some benefits their workers might have otherwise received. Again, any increase in price will lower their competitiveness. Another way is to endure lower net earning and live with it, but that means lower saving and investment for the whole economy. Plus, if they were to earn less, it would not make sense for them to stay anyway. As long as there is a substitution of labour force in another country, they are always able to relocate their factories.

Remember what I said about productivity. If your whole economy can produce 1 apple and $1, then an apple will be $1. When the economy still has 1 apple and wage rise to $2, then an apple will be $2. You are not better off because you still only get 1 apple. What about the others whose wages were not raised and sill receive $1? They can now only afford half an apple. Should we also raise wage for them too? Should we play the inflation (rising price) game? The problem is the higher the wage a company has to pay its worker, the more likely it would to retain its skilled worker and reluctant to accept new and unskilled ones. This means that wage hike will help the incumbents, but the unemployed/entrants will probably suffer pretty badly. Since rising wage can also transform to rising price (cost passed on to consumers), those whose wages remain fixed will suffer greatly, especially the unemployed who now find everything else less affordable.

But what worries me the most is the unbalanced urban-bound migration and simply mass job switching from agricultural sector towards labour-intensive industrial sector heavily centralized in traditionally low-wage garment industry, which will be economically unsustainable in the long run. First of all, it has to do with rising price of agricultural products because as more young farmers come to seek a better paid job within the city due to minimum wage hike, there will be less and less farmers to produce rice, fruit, meat and so forth. People might say that machines will be able to replace human labour, thus, render higher yield from agricultural production without the need of much labour, which as a result, will free up some labour to be employed in other industries. For those who think like this, my question to you is “Is PoorLand ready for this yet? Does it have all the agricultural machinery it needs to be in such favorable condition?” The answer is most likely a No No since most of the poor countries are still practicing traditional agricultural methods.

Furthermore, the higher wage for unskilled labour will most likely attract workers from many other industries causing labour shortage in those industries, not to mention upward pressure for the wages in those other industries and downward pressure on the wages in garment industry to keep everything within balance. However, with the minimum wage hike, there would be no room to move. This might lead to higher production cost and eventually higher price. Higher price? Yes. Why? Because the production cost (cost of labour) rises, and because we have the wrong impression of the economy. The economy, like I said again and again, is not better off having more money. That is nonsense. The economy is only better off in real term and in the long-run by having more goods and services. By forcing higher wages on garment industry, we are sucking up supply of agricultural products in exchange for supply of clothes. However, PoorLand might have better potential in agriculture, and poverty means more demand for food, less for clothes. So by instantly switching to labour-intensive industry, a few will gain while most will have to endure the heavy burden. And since minimum wages will drain workers away from other industries/businesses who cannot afford to raise wages, this negative outcome will most likely strike small and medium enterprise who will now struggle to find employees/labour. Though this might sound ridiculous, wage hike (drastic wage increase) can also discourage education among the poor, as better paid unskilled labour look more and more alluring, and the present demand prevails over that of the future.

More than that, wage hike makes it hard for employers to adjust during economic downturn. Do you know something called “ratchet effect”? It is this inability of human to reverse once a specific thing has happened. In other words, with higher minimum wage, the employers might find it hard to press it down when the economy is experiencing a recession because workers are most likely to resist any effects regressing them towards their former condition/state. This will force employers to layoff workers. So instead of everyone having a little bit of something, we now have some people with more and some with none.

If you ask me, is this fair? is this justice? No. No, this is not fair, but if you can convince the rest of the world to cut back on profit and suck on higher price to ensure level playing field, then raising wage might be a sound idea . However, by blindly trying to increase wage without realizing the cost, one might end up with nothing at all, or even worse, a decline.

Be careful not to let the minimum wage exceeds the market wage. This will spell out in a disastrous result. However, assuming it does not exceed the market wage, the free market dictates that the employers have the right to desire profitable business. Forcing them to reduce their profit is probably not that easy, but they might agree to raise wage by cutting back on something else (i.e. at a cost).

An abrupt wage hike can also increase the risk premium within a country, that is to say, it will lower the country’s credibility (thus, investment confidence which is hard to retain and regain). As a consequence, investors might demand higher interest rate or rate of return for their loan or investment, and they will be less likely to consider PoorLand as a potential investment target, which will hurt the economy badly in the long run as the total loss, if future loss is to be added, might outstrip the benefits of wage hike.

Of course, increasing minimum wages also has huge positive impacts which can offset the negatives. For instance, it can be a form of extrinsic motivation, increase consumption (thus spending which is good for the economy as long as it is at an appropriate level, which as mentioned, in proportion to the rise in productivity), force the employers to focus on efficiency and increase capital-human ratio to transform garment industry to being more capital-intensive, encourage participation in the workforce (workers in formal sector > workers in informal sector ===> more tax revenue for the government ===> allow for more spending on public service and so forth), lower government social net spending, just to name a few. However, it should never be generalized, i.e. it does not apply to every industry. A smooth and well-coordinated transition is needed.

What I would suggest here is to boost real income by focusing on the supply side. Agricultural production, physical infrastructure, capacity building (vocational training, etc), and various governmental institutions (especially in terms of education) should be the key factors to be focused to ensure long-term sustainable growth. Demand side (i.e. raising wage) should be stimulated only when there is sufficient and appropriate level of supply to buffer the potential negative impacts.

All in all, wage is not an ends. Job is not either. Having enough food, warm shelter, and decent living standard are what we need. Objectively speaking, a great policy is not the one that pleases the most people, it is the one with most positive impacts that can offset the cost (negative effects) it incurs. So before implementing a policy, it requires great understanding and rigorous research of the economy. However, research on different countries yield different results. We should gather our experience from international best practice, but PoorLand should not look at research on minimum wage policy in RichLand whose characteristics differ greatly from PoorLand’s. PoorLand should instead study any research relevant to wage policy in another developing or least-developed nation.

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Image sources:

Image 1: http://www.secretsofthefed.com

Image 2: http://www.employmentlawuk.org/national-minimum-wage-increases-to-6-19-per-hour/

Image 3: http://www.spaceoffice.nl/nl/Satelliettoepassingen/Toepassingen/Agro-food/Micro-verzekering/

Image 4: http://cloudtimes.org/2013/02/15/turning-data-into-profit/