Do we need a national minimum wage to improve income equality?

The ANC has pledged to investigate the introduction of a national minimum wage “as one of the key mechanisms to reduce income inequality”.[1]

Will it work?

When contemplating this question, I suddenly wondered: Are there in fact any countries with no form of minimum wage? And if so, what happens there? What I discovered, was most interesting. Surprising in many ways.

But first of all, a bit of structure: The term “minimum wages” can be used in one of two ways: It either means a national or regional minimum wage set by the government or one of its agencies, or it means a wage negotiated by unions and employers in industry-specific collective bargaining forums and then often extended by law to other players in the particular industry.

Many countries do not have minimum wages in the former sense, but then do in the latter sense. And believe it or not, there are a few countries – only a few mind you – that have neither type of minimum wage.

It is important to know that normally the first type of minimum wage has universal application, whilst the other only applies to specific industries, sometimes only to parties to the bargaining structure, and sometimes also to non-parties. This is useful to know, because if minimum wages hamper employment creation, then we would expect minima that apply to sections of the workforce only, to be less damaging.

The other piece of structural understanding that is useful, is that there are countries where there is no minimum wage, but the economic market is not free – that is, it is over-regulated. Those countries do not really assist in assessing the employment and wage outcomes of the absence of minimum wages. Predictably their economic performance is poor, and for purposes of this discussion they be discarded[2].

First of all, let us then look at the countries where until recently[3] there was no minimum wage at all, and where there is a relatively free market. The data is summarised in the following table:

 

Country Economic Freedom[4] Per capita GDP[5] Unemployment[6] Gini coefficient[7] Income poorest decile (p/a)[8]
Brunei 7.05 $54144 2.6% n/a n/a
Qatar 7.62 $100889 0.5% 41.1 n/a
Singapore 8.60 $60799 1.9% 48.1 $9379.4
Hong Kong 8.87 $50936 3.3% 53.3 $7693.7
UAE 7.85 $29176 4.3% 31 $26372.8
Average 7.998 $59189 2.52% 43.4 $14482
World average 6.87 $11964[9] 9% 52[10] $8410.61
Peer average[11] 7.75 $47765 6.42% 31.46 $19524

 

The following clear trends appear:

  • All 5 countries with no minimum wages are very rich – bar one they fall in the top ten richest countries in the world.
  • All the countries (both those with minimum wages, and the peer group of high-income countries) have relatively free markets.
  • The countries with no minimum wages outperform their peers in terms of per capita GDP by a considerable margin (about 25%).
  • Their Gini coefficient (measuring income inequality) at 43 compares well with the world average (52), but lags behind the average Gini of their peers (31).
  • The absolute income of their poorest 10% is better than the world average, but significantly worse than that of their peers.
  • Significantly, the no-minimum wage countries vastly outperform their peers in terms of unemployment (2.5% vs 6.42%).

What does all this mean for policy in South Africa?

What we can see, is that it is possible, even likely, to have high income and low unemployment in a no-minimum wage set-up. But we also see that inequality is higher in these societies than in their peer economies. Does that mean that job growth comes at the expense of inequality, and how important is that?

For purposes of the current discussion, we can discard the three oil-producing countries of Qatar, UAE and Brunei. Each of these countries showed GDP trends that tracked the oil price over the years, and are examples of almost artificial economies that generated obscene amounts of wealth during oil boom times, and had reversals of fortune in other times. So for example:

  • Between 1970 and 1980 (the period of the so-called oil crisis) the crude oil price measured in constant prices rose to an unprecedented peak. During this period the per capita GDP of the three countries all rose dramatically and peaked in 1980, in tandem with the oil price. Qatar’s per capita GDP, for example rose from $4929 to $35029 in that period.
  • When the oil price dropped in 1998, it reached a low of $18634.
  • In 2012, again in tandem with the oil price, it reached a high of $93831.
  • Personal income fluctuated in a similar way. So for example the per capita income in the UAE almost doubled in the period 1995-2007, a period during which the oil price shot up to record highs.
  • Besides, Brunei and Qatar have been so coy with their equality data that it is impossible to evaluate them for present purposes.

That leaves Singapore and Hong Kong. Both of these countries are useful in our case, because they are diverse, heterogeneous societies which at one stage needed to lift almost their entire population out of poverty. During the mid-sixties the two countries and South Africa were peers – waiting in in the emerging-country starting blocks as it were, at about $650 GDP per capita each. Since then Singapore and Hong Kong have grown to $50000 and $36000 respectively, while SA still lounges at about $7000.

Both East Asian countries experienced increases in inequality over the last 2-3 decades. In Hong Kong the Gini coefficient increased from 4.53 to 5.33 between 1985 and 2008, an increase of 17%[12].

In Singapore it increased by a similar percentage (17%) over the period, namely from about 4.1 to 4.8.

By way of comparison, over the same period, the OECD countries increased their aggregate Gini coefficient by 10.3%[13]:

Again: Does that mean we in South Africa will be better off, and more effectively combat inequality by introducing a national minimum wage?

Inequality Watch did a study in 2012[14] that compared and assessed OECD countries in terms of changes in inequality that they underwent from 1985 to 2008. Whilst noting that there was a general trend during that period for inequality worldwide to increase, there were significant differences between individual countries.

The authors discovered that there were in fact three groups of countries:

  • Two countries that bucked the trend and managed to decrease inequality over that period, namely Turkey and Greece
  • Countries that also bucked the trend, but by maintaining the same level of inequality: France, Hungary, and Belgium; and
  • Countries whose income inequality increased: The USA, the UK, Australia, Canada, Finland, Sweden, Denmark, Norway, Portugal, Italy, Germany, Italy, Germany, the Netherlands and Austria (by about 13% on average).

What is significant about these statistics is that the average unemployment rates of the three groups differ markedly:

  • The group that managed to reduce inequality, has average unemployment of 18.65%;
  • The group that maintained inequality at a constant rate: 9.3%; and
  • The group whose inequality increased: 7.6%.

It is quite clear that countries that succeed in maintaining or reducing inequality, tend to suffer higher unemployment.

To see what role national or regional minimum wages and other forms of minimum wage-setting (such as collective bargaining, with or without extensions to non-parties) play in this trend, I grouped the countries into two groups, namely those with state minimum wages and those with other forms of minimum wages. The average unemployment of the two groups is as follows:

  • Those with state-mandated (universal) minimum wages: 10.4%;
  • Those with other forms of (non-universal) minimum wages: 7.07%

Now it will be remembered that we analysed the countries that have neither type of minimum wages, and that their average unemployment rate was 2.52%.

So it seems that a country that wants to reduce its unemployment, is clearly better off without any form of minimum wages. Although it appears to be marginally better to have parties negotiate minimum wages in collective bargaining structures, that is exactly what it is: only marginally better. First prize goes to a free-market economy with no minimum wages.

The other lesson that we learn from this is that it is possible in a modern economy to reverse the international trend towards inequality, but that comes at an enormous price in terms of unemployment. Even just maintaining the same level of inequality, exacts a massive pound of flesh in terms of lost jobs.

The above statistics thus seem to confirm what many left-wing commentators have been telling us for years: the minimum wage helps to maintain or improve equality.

So does that mean we should introduce the minimum wage in South Africa?

Not so fast.

As we have already seen in another article[15], in South Africa at this stage of our development, inequality is in fact reduced by reducing unemployment:

 

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It follows that we in South Africa must do whatever we can to grow employment, if we are serious about reducing income inequality.

But even if job creation does increase inequality, (as some of the above statistics suggest), does that still mean that we should not do everything in our power to give jobs to the 7 million unemployed?

The point that we must not lose sight of when assessing job creation as a tool to reduce inequality, is that a country with successful job creation also grows the wages of the poorest workers. In the two examples that we looked at earlier, namely Singapore and Hong Kong, this is illustrated very well. In 1985, for example, a Hong Kong worker in the poorest 10% of the workforce (precisely the group that the minimum wage would normally target) would have earned about $1560 in current prices. Today that same worker would earn $7693, a fivefold increase in real terms. Singapore’s figures yield a similar result. In short: Whilst adding about a million jobs (about 38%) to its workforce, Hong Kong also grew its lowest-paid workers’ income by 500%. No wonder it did not bother with minimum wages.

Ultimately the actual level of pay of the poorest 10% is a function of how free the market is in which they are employed. The freer the market, the higher the actual income:

The amount per capita, as opposed to the share, of income going to the poorest 10% of the population is much greater in nations with the most economic freedom than it is in those with the least[16].

 

 Screen Shot 2014-02-19 at 10.45.19 PM

In South Africa the hard policy question that we must ask, is whether we dare flirt with the idea of improving inequality by means of minimum wages. If we look at the tragic price paid by Turkey and Greece in terms of job losses, it hardly seems worthwhile. Besides, it seems as if we, at our current stage of development, will in any event improve our income equality if we simply do whatever we can to increase employment.

Finally, it boils down to this: will a national minimum wage help or hinder job creation?

Few industries offer as dramatic an illustration that a sanguine attitude about the effects of minimum wage legislation on employment growth is misplaced, than does the agricultural sector.

Haroon Bhorat and others, in a study[17] on the minimum wage introduced in the agricultural sector in 2003, drew certain startling conclusions.  This study made use of figures provided by the Quarterly Labour Force Survey of Statistics South Africa, to determine the level of employment in the agricultural sector both before and after the introduction of minimum wages in 2003, namely from September 2000 to September 2007.  Here is a sample of the statistical results found by them:

“… the number of farm workers falls by almost 200 000 between September 2002 and September 2003, which is a decrease of over 20% …  The data shows that over the period, employment in the control group rises steadily over time while farm worker employment starts falling in March 2003 (the law was announced in December 2002) and does not recover.”

Agric

Immediately before the introduction of the law, the estimated number of employees was 824 954 in the sector, whilst a year later it was 622 328 (2003), declining to 574 101 in 2007.  The study rules out other factors such as economic growth/decline in explaining the results.

In conclusion the authors then state:

“Our results suggest that the sectoral minimum wage law in agriculture in South Africa had significant effects, as farm worker wages rose by approximately 17% as a result of the law … In examining the effect that the minimum wage had on employment, this paper shows that … employment fell significantly in response to the law … the probability of employment as a farm worker was shown to have fallen by approximately 13% in the post law period.  Such effects are largely supported by the new minimum wage literature where Neumark and Wascher (2007) emphasised that this employment effects are more likely when aggregate data is analysed – particularly for unskilled workers.”

It is worth quoting the following extracts from the abstract summary of the cited study of Neumark and Wascher (which did a wide-ranging literature review of available research):

“….. the oft-stated assertion that recent research fails to support the traditional view that the minimum wage reduces the employment of low-wage workers is clearly incorrect. …..among the papers we view as providing the most credible evidence, almost all point to negative employment effects, both for the United States as well as for many other countries. Two other important conclusions emerge from our review. First, we see very few – if any – studies that provide convincing evidence of positive employment effects of minimum wages, especially from those studies that focus on the broader groups (rather than a narrow industry) for which the competitive model predicts disemployment effects. Second, the studies that focus on the least-skilled groups provide relatively overwhelming evidence of stronger disemployment effects for these groups.(Emphasis added).

It is no coincidence that farm workers have proved to be very vulnerable to the minimum wage law. The average characteristics of farm workers surveyed for purposes of the study, were:

  • they were typically African (being the most disadvantaged historically), and
  • they had between 7 and 8 years of education.

In a nutshell: they were typical of the most vulnerable group of marginal workers, with the exception that women are probably even more exposed to economic depredations. The typical farm worker comes from that sector of society that is by far the most exposed to unemployment and poverty.

Seen from the perspective of labour market policy, it is precisely workers like these – marginal workers – who most need to be absorbed into the economy.  The proportion of the unemployed who have not completed secondary schooling is 59.7%, amounting to more than 2.8 million workers[18].  These numbers are particularly disturbing if one considers that the labour market participation rate for African people in 2012 was 51.8% (compared to, for example, the United Arab Emirates at 91%, Brazil at 85%, China at 85% and India at 85%).  That means that in South Africa almost half of all Africans of working age are not part of the economically active population, and have lost all interest in finding work.  The result is that in 2012 the labour force absorption rate of Africans, namely the proportion of working-age Africans that is employed, was a paltry 36.9%.  That means that more than 60% of Africans of working age are idle.  These are the people who need to be drawn into the labour market if we are serious about fighting poverty and reducing inequality.

Since 2010 events at least as dramatic as those in agriculture, have been playing themselves out in the clothing industry. In that year hundreds of employers were fingered by the National Bargaining Council for the Clothing Industry for breaches of minimum wages and other prescribed terms and conditions of employment imposed on them by the extension of bargaining council agreements.  In the end the closing down of several hundred employers was prevented only because of political intervention, whereby a moratorium was imposed, saving not only the employers, but thousands of employees employed by them.

If the bargaining council in the clothing sector had followed through on its initial threat to levy execution against the recalcitrant employers, it is certain that hundreds of them would have closed down and thousands of employees would have lost their jobs. Although skilled to a degree, workers in the clothing sector, especially these marginal ones who stood to lose their jobs, are not highly educated and trained employees. And yet they have the ability to make a real contribution to wealth creation if allowed to charge market-related wages for their services.

The reason why the unskilled and low-skilled sector is an obvious victim to laws such as minimum wage legislation, is fairly obvious.  It is the marginal worker who needs to offset his lack of training, skills and experience with the compensating advantage of accepting a lower wage.  That lower wage will very often fall below the prescribed minimum wage.  This truth has been abundantly illustrated in the agricultural sector example cited earlier.

At the time of the introduction of the minimum wage, the market wage in that industry was at least 17% lower than the minimum wage on average. It is no wonder that dramatic results followed. The same applies to the clothing industry, where for example in non-metro KwaZulu-Natal, 3 200 employees worked in firms where the lowest wage was R300,00 per week, at a time when the prescribed minimum wage was R684,25.

In South Africa we must bear in mind that we have another problem that greatly exacerbates the threat of unemployment through the operation of minimum wages, and that is our notoriously ineffectual education system and resultant low levels of literacy and numeracy. We absolutely have to find work for the millions of almost unemployable workers who are victims of this system. There is no time or resources to educate the school leavers who have already been released onto the employment market. It is enough of a burden to try and bring the standards of education of the current body of learners up to scratch; it is a forlorn hope to attempt to play catch-up with workers already in the labour market. Their best hope by far is to get jobs, albeit at modest wages and terms of employment, so that they can at least start acquiring some skills through on-the-job training, which will make them better employable, give them a chance of promotion and advancement and improve their bargaining power.

If South Africa is serious about addressing the plight of the most vulnerable sector, namely the typical unemployed person who is African, lowly educated and lacking in skills, and thus address inequality of income, the last thing in the world we should do is to introduce a national minimum wage.

 

 


[1] IOL BusinessReport 14 January 2014

[2] A good example is Ethiopia, which occupies position 141 on the Economic Freedom of the World Index 2013

[3] Hong Kong only got the minimum wage in 2011, too recent to influence the outcomes given here.

[4] Freedom of the World Index 2013

[5] IMF

[6] Wikipedia based on various official sources

[7] Wikipedia based on various official sources

[8] Euromonitor International ltd: World Consumer Income and Expenditure Patterns 2013

[9] Wikipedia based on various official sources

[10] Conference Board of Canada

[11] Average of peer states selected on basis of average per capita income: Australia, Austria, Canada, Ireland, Luxembourg, Netherlands, Norway, Sweden, Switzerland, USA.

[12] Lap, Tung, Hi: Income Inequality in Hong Kong

[13] Inequality Watch

[14] The Rise of Income Inequality amongst Rich Countries (2012)

[15] The Effect of Regulation on Unemployment

[16]Economic Freedom of the World 2013

[17] Bhorat, Kanbur & Stanwix: Estimating the Impact of Minimum Wages on Employment, Wages and Non-wage benefits: The case of agriculture in South Africa, University of Cape Town 2012.

[18] SA Institute Of Race Relations

1

The Effect of Regulation on Employment

Let me start by making something clear: I want the poor to be exploited.

That’s it. I’ve said it: exploit the poor. My biggest concern is that not enough employers in our economy exploit the poor. The result is that they do not work, do not earn an income, do not learn on the job, do not get promoted, do not buy houses, and do not send their children to school.

All because they do not get exploited. Because over-regulation makes it impossible to exploit the poor.

When I am concerned about the poor not being exploited, and when the trade unions are concerned about reduced standards, we are all in effect worried about the marginalised workers. These are the workers most at risk of not getting jobs – workers such as:

  • historically disadvantaged people, typically blacks;
  • the uneducated;
  • people from poor households with few resources;
  • youthful workers.

How can these poor people best make their way in the world? The best way for them to make their way in the economic world is to get jobs.

Of course, we can say that they should first become educated, but for the time being we do not have that luxury. On the whole the unemployed are poorly educated, and in the mean time they have to eat.

For the time being the fact is that our education system is in a mess, and that thousands of poorly educated workers are released on the marketplace on an annual basis.

So how must these poorly equipped marginal workers find jobs?

Let’s deal with this by way of an analogy. Let’s accept for the moment that chuck steak is regarded by the consumer as less desirable than fillet. Let’s say chuck steak sells for R50 a kilogram, whilst fillet sells for R150 a kilogram. For the chuck steak to be attractive enough so that available supplies can be bought up by consumers, the seller has to compensate by means of a lower price. If the supermarket or the butcher should insist that both kinds of meat should sell at R150 a kilogram, the chuck steak will not sell. In fact, to translate it into economic terms, it will remain “unemployed”.

Now suppose legislation was passed which compelled supermarkets to sell chuck steak and fillet at the same price of R150 a kilogram, whilst market forces would dictate the prices of R50 and R150 respectively. The result would be predictable. The chuck steak would remain unemployed.

Of course, a predictable objection to using such an analogy is that employees are not pieces of steak, and cannot be analysed as such. One may well ask: Is it fair that some individuals, through no fault of their own, have to work for a lower wage in order to become employed?

It may arguably be unfair that that is so, but that does not change the facts. The facts are that if by law minimum wages and other terms and conditions of employment are imposed on employers who wish to employ marginal employees, those employees will either lose their jobs or never be employed in the first place. Like “chuck steak” the law then renders them unable to offer a compensating advantage for their lack of skills and experience. They are by law prohibited from offering their services at a lower rate to compensate for their less desirable employment qualities. In short, we are outlawing their employment.

If, on the other hand the government should allow chuck steak to be sold at R50, or the employee to sell his labour at its natural market wage, both will sell to its maximum potential.

The purpose of labour laws generally is to improve the working conditions of employees. That means that they are aimed at one of the following changes:

  • Setting a minimum standard for wages, benefits or hours of work and similar conditions;
  • Improving workers’ bargaining power by protecting trade unions and strikes; and
  • Protecting workers against unfair dismissals or other unfair labour practices.

It does not really matter in which of these categories a particular labour law provision falls. The bottom line is the bottom line: in other words, each of these provisions exacts a cost from an employer. In the case of the minimum wage and similar conditions, self-evidently an employer has to fork out more money in order to meet the minimum benefit than he would otherwise have done. (It is of course possible that a minimum standard of employment is set so low that employers in the market exceed it in any event, but that is not the type of minimum standard which interests anyone, least of all the employees and trade unions.)

Employers also need to fork out more money in order to pay workers represented by trade unions and workers on strike. The simple economic fact is that if employees have higher bargaining power, as they undoubtedly have where trade unions and strikes are protected by statute, employers end up paying more in order to secure the co-operation of their workforces. Finally, unfair dismissal legislation exacts a price not only for the otherwise productive hours spent by employers in disciplinary hearings and similar proceedings mandated by law, but also for legal expenses incurred in fighting disputes as well as compulsory retrenchment and similar packages. Many disputes end up in compensation awards payable by employers, also in the case of unfair labour practice and unfair discrimination disputes.

The result is thus that the total package that employers have to fork out – whether by way of cash or lost productivity – increases pursuant to benefits to which employees are entitled as a matter of law.

The cost argument can also be approached from the viewpoint of a future investor. Although a potential investor does not necessarily consider labour laws in his calculations whether or not to invest in the labour market of a country, he undoubtedly considers potential profitability. In doing so he projects the likely unit labour cost having regard to the market price of labour as influenced by labour law and other factors, as well as the demand for the product. If he concludes that there is insufficient demand to provide a satisfactory return on his investment, he will not invest. If the cost of labour as influenced by labour law is therefore such that he concludes that his investment is not worthwhile, he simply will not create any new jobs.

What is the evidence: What impact does regulation have on employment?

First, consider general economic legislation, as opposed to labour laws. Although general economic regulation may not be intended to impact on the labour market, it often has such unintended negative consequences for employment.

A number of internationally recognised indices measure the degrees of regulation of countries. They typically identify the following areas of regulation in calculating a quantitative assessment of what it calls the economic freedom of the country:

  • Size of government: expenditures, taxes and government enterprises;
  • Legal structure and security of property rights, including impartiality of the courts and absence of crime;
  • Access to sound money, in particular sound monetary management and anti-inflation policies;
  • Freedom to trade internationally, including tariff barriers and international capital market controls;
  • Regulation of credit, labour and business markets.

In the 2011 annual report of Economic Freedom of the World, for example, 152 countries are evaluated. Hong Kong, for a number of years running, has been the country with the highest score for economic freedom, namely 8,97 (out of a maximum of 10). Venezuela brings up the rear with 3.93. South Africa, has dropped from 41st place in the rankings in 2000 (when its score was 7.08 – its best performance since democracy) to 64th with a score of 6.8 in 2011. In other words, while South Africa’s absolute score has declined marginally, its relative ranking has slipped 23 places in a decade. That means that South Africa’s net relative competitive position compared to those of other countries, has declined. Because all countries compete in the same global market, what matters is the relative competitiveness of a society as much as its absolute score.

In answering the question what the impact is of economic freedom as measured by the report, the authors used a number of criteria to present evidence of the superiority of free markets. In order to do this, they have divided the participating 152 countries into 4 quartiles, ranking from the least free quartile to the freest quartile. In the statistics that follow below, the figures cited rank from the least free quartile to the freest quartile. In each case it will be apparent that, as a general trend, freer markets are significantly superior in achieving good performance according to any of the criteria chosen:

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Economic freedom and per capita income
Countries with more economic freedom have substantially higher per capita incomes.

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Economic freedom and economic growth
Countries with more economic freedom have higher growth rates.

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Economic freedom and the income share of the poorest 10%
The share of income earned by the poorest 10% of the population is unrelated to the degree of economic freedom in a nation.

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Economic freedom and the income level of the poorest 10%
The amount per capita, as opposed to the share, of income going to the poorest 10% of the population is much greater in nations with the most economic freedom than it is in those with the least.

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Economic freedom and life expectancy
Life expectancy is over 20 years longer in countries with the most economic freedom than it is in those with the least.

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Economic freedom and civil liberties
Civil liberties (e.g. freedom of speech) go hand in hand with economic freedom. (Here the smallest number indicates the greatest degree of civil liberty)

It is hard to argue with these statistics. It should be emphasised that the measure of economic freedom adopted by the authors does not imply anarchy or no regulation at all. However, where regulation is to improve the score of a country, it is invariably regulation that ensures good governance, effective court systems, protection of property and prevention of crime – ie regulation that protects economic freedom, rather than limit it. On the other hand, factors that tend to detract from the score are the size of the government, the level of taxes, an inflationary environment, interference with international trade, tariff barriers, interference in credit markets, labour market regulation generally, licensing, high start-up costs and price controls.
Whereas the 2011 report does not contain any attempt at establishing a correlation between economic freedom and employment, it would not be surprising if such a correlation existed. What do the figures in fact show?

Unemployment
Countries with more economic freedom have lower unemployment.

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What is interesting about this result is that those countries that fall in the first quartile, namely the freest countries, perform significantly better than the other quartiles, whilst there is less difference between the remaining quartiles. The lesson from this is that it pays a country that is interested in job creation, as far as possible to put in place all the ingredients of market freedom, and not to neglect any. This will have an exponential or multiplier effect on employment creation.

Does labour law itself have an influence on the likelihood of unemployment in an economy?

The argument about whether this is so or not, has raged on for years. The difficulty is that many factors influence job creation, and it is hard to rule out factors other than labour legislation in determining its influence statistically. The following factors undoubtedly play a role in this context:

  • The extent to which the relevant labour laws are actually enforced in practice. It is all very well having a plethora of black-letter regulations; but if the state does not have the will or the wherewithal to enforce them, they are next to meaningless.
  • Allied to this is the factor of the size of the informal economy, especially that part of it comprised by illegal immigrants. To a large degree informal employees do not enjoy the benefits of labour law.
  • As I show in a later article, of crucial importance is the demographic make-up of the country in question, notably whether it is homogenous or heterogonous in terms of ethnic, religious, linguistic and educational criteria.
  • As appears from the earlier section on the effect of regulations on employment generally, the degree of freedom of the relevant economy – above and beyond labour law – is highly relevant..

So the challenge is to try and design a study that isolates the impact of labour laws, whilst excluding the other and similar factors as well as possible.
One such a study is to one done by Timothy Besley and Robin Burgess entitled Can Labor Regulation Hinder Economic Performance? Evidence from India.
The introduction to the paper summarises it as follows:

This paper studies the role of labor market regulation in explaining manufacturing performance in Indian states between 1958 and 1992. Such regulation is frequently cited in explanations of India’s poor growth performance over this period.The charge is that granting excessive bargaining power to organized labor blunted investment incentives and gave India a generally unfavorable business climate. Our data on labor regulation come from looking at state amendments to the Industrial Disputes Act of 1947. While the act was passed at the central level, state governments were given the right to amend it under the Indian Constitution. The emphasis on central planning in India meant that state governments have had limited influence on industrial policy outside the area of industrial relations. We read the text of each amendment (113 in all) and classified each as pro-worker, pro-employer or neutral. This gave a sense of whether workers or employers benefited or whether the legislation had no appreciable impact on either group. Regulation applies to a specific sector — formal manufacturing — smaller firms in informal manufacturing are not covered.”

The significance of the study lies therein that all the states investigated come from a single country, which is India. Whilst these states are by no means identical, they are sufficiently similar to rule out the influence of factors such as those listed above. India is generally a very heterogonous society, irrespective of state; it can be assumed that states have more or less similar enforcement capacities; and as the paper asserts, apart from labour law, most economic regulation is done at national level, and is thus common to all states
The authors conclude:

The evidence amassed in the paper points to the direction of labor
regulation as a key factor in the pattern of manufacturing development in
India. Regulating in a pro-worker direction was associated with lower levels
of investment, employment, productivity and output in registered manufacturing.
It also increased informal sector activity.”
and
The paper finds little evidence that pro-worker labor market regulations
have actually promoted the interests of labor and, more worryingly, that they
have been a constraint on growth and poverty alleviation. Our results have
not been able thus far to find any gainers except for the extent to which
there may have been capital and labor flows across Indian states in response
to policy disparities as they have developed. Our finding that regulating
in a pro-worker direction was associated with increases in urban poverty are
particularly striking as they suggest that attempts to redress the balance of
power between capital and labor can end up hurting the poor.”

Another study by Thomas A Garrett and Russell M Rhine1 compared the economic freedom, and separately also labour market freedom, of the different American States. In addition to finding that the general level of economic freedom is positively correlated with employment growth, it also found that labour regulation is specifically significant in this context:

Further results suggest that labor market freedom and a smaller state government, which are two components of overall economic freedom, are important determinants of employment growth across U.S. states, with the former factor the more important”.

It follows that if South Africa is interested in improving its job creation record, it must seriously consider improving its general economic freedom score, and also in particular its labour market freedom score.

Why are we still arguing?

It is quite simple really. The law pushes up the cost of labour. So employers buy less of it. Why then do we keep on arguing about it?
I have over the years encountered a number of dearly held myths, that explain why even those who are in good faith on pro-labour law side of the debate (whom I call the “pro-lawyers” for short), honestly believe they are right. It is necessary to deal with these.

Myth 1: Deregulation will lead to a race to the bottom

This a a serious myth, because most people really believe it. The most obvious reason why labour law protagonists so fervently support it, is because they really care, and believe employees without the protection of labour law will be exploited and standards will become progressively lower and lower as employers are left without any incentive to improve working conditions of employees.

Often they ask in all good faith: Does deregulation not mean that increased job creation by removing expensive labour laws will breed a low-wage workforce whose conditions of employment will never improve? Does the government not have a point when it says that removing existing protections and minimum conditions will lead to a downward spiral of ever-worsening employment conditions? Or as it is sometimes put, “a race to the bottom”?

This is one of the most persistent ideas amongst pro-lawyers, and one which is hard to shake. The perception, which is surprisingly common even amongst commentators who should know better, is an understandable and intuitive one: Surely, they reason, if you remove, say, minimum wages, employers will be free to pay lower and lower wages, and will continue doing so in order to remain competitive – not only with their local counterparts, but also with overseas competitors. This process will feed on itself, with the result that workers will get paid less and less over time.

To understand why a so-called race to the bottom will not occur, it is important to bear in mind how the labour market works.

At the risk of repetition, the labour market is a market like any other. As long as marginalised workers can charge market wages for their services (even if that is lower than minimum wages that the State would prescribe) employment will grow. It will do so because the economic law of supply and demand dictates that demand for a good or service rises if it becomes cheaper.

At first workers will be employed at wages that are lower, most likely significantly lower, than the erstwhile prescribed minimum wages, and on conditions that probably give less protection to employees than what the law used to mandate.

However, the labour market being a market like any other, as soon as employment increases because more employers are able to pay wages and accommodate conditions for and under which workers are prepared to work, the demand for workers will increase labour becomes scarce.
As soon as that happens, workers’ bargaining power will increase, because their labour will become a more sought-after commodity. That will mean that they will in time be able to demand better working conditions and higher wages.

Employers will have to meet these demands, or run the risk of losing the workers, and losing out to the competition.

At the same time employers will be forced, by reason of increasing wages, to train workers and improve their productivity.

Workers for their part will have the opportunity through on-the-job training to increase their bargaining strength and become more employable.
All of these factors will thus inexorably push wages upwards.

Real-world examples of this phenomenon are not hard to find. The following are outstanding examples of countries with relatively lowly regulated labour systems, taken from the period 1994-2003:

  • Vietnam maintained per capita income growth of more than 5% per year (in real terms), while achieving unemployment of under 3%.
  • The UAE managed to improve the average income of workers by over 4% per year (again in real terms), and to limit unemployment to under 5%.
  • In case of doubt about the ability of an African country to achieve such results, Uganda achieved per capita income growth of 2.5% against unemployment of 3.2%.

Historically a prime example of a country which achieved a spectacular “race to the top,” is Taiwan (once again with a very lightly regulated labour market), which performed as follows in the period 1961 to 1987:

1961-71 1971-81 1981-85 1986 1987
GNP growth per annum 9.9 9.4 6.5 11.6 11.2
Unemployment 2.5 1.6 2.3 2.7 2
Gini coefficient 37.2 31.1 31 32.2
Real manufacturing wage increases 6.2 8.0 5.5 9.3 9.7

Far from there being a race to the bottom, the opposite is likely to occur.

Examples in other countries where labour deregulation took place, support this conclusion too. In 1991 New Zealand introduced the Employment Contracts Act, that brought about significant if incomplete deregulation of the New Zealand labour market. Amongst other things, it significantly reduced artificial statutory support for trade unions, and abolished centralised bargaining structures that prevented employers and employees from concluding their own, individual contracts of employment. The results were most encouraging:

  • Between 1991 and 2007 unemployment fell from about 11% to under 4%;
  • During the same period the labour force participation rate increased from 63% to 69%;
  • Most significantly, GDP per capita in real terms increased from about $20000 to $30000.

It is simply not true that deregulation is likely to lead to a plummeting of labour standards. Quite the contrary.

Myth 2: Mandated minimum terms and conditions improve average welfare

Another reason for the inability of people like me and the pro-lawyers to see eye to eye has to do with a misconception about the nature of jobs, welfare and wealth.

I call this myth the wage fallacy. It is the fallacy, put at its simplest, that believes that aggregate welfare of people in the economy will improve if we can manipulate wages and other employment terms in an upwards direction. It is related to the belief that money is wealth, which is the fallacious premise underlying all inflationary monetary policies.

The fallacy is implicit in the government’s policy of maintaining a system of labour laws that is designed to improve the terms and conditions under which employees work – in other words, to make employment more, rather than less, expensive for employers.

When it introduced minimum wages in the domestic workers sector some years ago, in its memorandum in support of the legislation it admitted that jobs would be lost as the result of the increases. But the job losses were justified on the basis that they would ensure a basic living wage for employees in the sector. (Read: people will become more wealthy).

Of course, there was no suggestion as to what should happen to the employees who lost their jobs through this process, or worse, who were never employed in the first place. The government seemed to believe that the trade-off between higher wages and lower employment was justified in the circumstances.

Enter the wage fallacy. Decreeing “decent work” is not a straight trade-off. It is not a case that some jobs are simply sacrificed for better working conditions.

The workers who are put or kept out of jobs do not work, which means that they do not create wealth.

Stop there for a moment. Ask yourself: Why do we work? We work in order to create wealth: To create houses, cars, transport, food, clothes, haircuts, entertainment, health services, education. Everything and anything that the market regards as valuable and is prepared to pay for. There is no other point to employment.

Wealth creation is what enables the economy to grow, and more jobs to be created. The moment you decide to sacrifice some jobs for the sake of better working conditions, you must know that you do not merely sacrifice jobs. You sacrifice the wealth that those jobs would have created.

Take the case of a furniture worker. If a furniture employer is forced to lay off workers, that means that those workers no longer make furniture that can be sold to members of the public. The reduced supply of furniture will push up the price of furniture.

It can also happen that an employer, faced with mandatory wage increases, is forced to employ machines in order to do the work previously done by the employees. That is likely also to push up the price of furniture, because if the employer before the mandatory increase could have made furniture as cheaply using only machines, he would have done so in the first place.

The bottom line is that unemployed workers are unproductive workers. That means that they are not able to contribute to the wealth of society, but instead become net consumers of benefits funded by the public purse – to which a smaller and smaller percentage of productive citizens contributes.

The wage fallacy has another manifestation, which we can call the welfare fallacy. At the moment our government gives out more welfare grants than there are tax payers to fund it. That in a nutshell summarises the problem of our inability to conquer poverty. Recipients of welfare do nothing in return for the payments they receive. They create no wealth. Approximately 10% of the population pays the tax on which the vast majority survives. That vast majority do not help create the wealth on which the welfare of the nation should actually rest.

The problem is not jobs first and foremost. It is lack of wealth creation. Poor people suffer because they do not create or have wealth – houses, food, transport, medical care. A job is not wealth. It is just a contractual deal whereby a person’s labour (his wealth-creation capacity, if you like) is engaged. But its economic purpose is to create wealth.

That is why it matters if workers in the clothing industry are laid off, or their employers are closed down because they are not willing or able to pay minimum wages mandated by the bargaining councils. Those factories and workers effectively stop creating wealth in the shape of clothes. Thus a source of affordable clothes for poor people is closed down. The supply of clothes is reduced. The moment that happens, competition in the domestic clothes market is reduced, and consumers (most of whom are poor) are forced to buy more expensive clothes. Instead, by keeping those factories in business by allowing them to pay market-related wages, other manufacturers, and importers of Chinese clothes, would be forced to keep their prices low. By mandating “decent wages” for clothes workers, we thus undermine the creation of wealth by restricting the supply of cheap clothes to poor people.

Agriculture is another example that makes the same point. Partly by reason of labour laws, the number of people working in agriculture has dropped dramatically over the last decade or so. The net result is that less South African produce in the form of meat, vegetables and grains comes onto the market, forcing South Africans to buy imported food at higher prices.

Employment is part of the modern economy’s system of division of labour. We can notionally view our South African economy as a giant wealth-creation enterprise in which all the workers get a share of the wealth they make. But rather than reward workers in a food factory by giving them food, or those in a clothes factory clothes, it is more efficient to give them money that they can exchange for other forms of wealth. Viewed as a whole like this, it is clear that the economy will be wealthier, and so will its participants, the more workers work in it.

We thus need a system under which more and more workers are employed, so that they can make a contribution to creating more wealth than would be the case if they stayed idle.

Just stand back for a moment and consider this: In the current setup we have about 10 million workers earning mandated minimum wages in some form or fashion. Let’s suppose we could employ them, and the remaining 7 million unemployed workers, at market wages – that is, without the intervention of labour laws. Then 7 million more workers would all be creating wealth. Not only would that almost double the wealth creation – ie the GDP of the country – it would also give each of those 8 million a share of that wealth in the form of a wage.

That will be infinitely better than artificially pushing up the wages of the 7 million who are in formal jobs. No significant increase in wealth creation will take place as the result of such a move.

It is of course conceivable that an employer, in response to the increased costs imposed by law through labour laws, will feel compelled to, and succeed to, increase his labour productivity in order to meet the cost increases imposed by law. So, for argument’s sake, let us say a minimum wage law compels an employer to increase his monthly wage by 10%. The only practical way in which that employer can recoup the loss caused by such an increase, is by increasing his productivity. If the object of the exercise is to recoup the loss, the economic incentive of the employer will be to improve his productivity to the point where the loss is in fact recouped. In other words, it is unlikely, since there is no incentive to do so, that the employer will increase the labour productivity beyond that point. In other words, the employer will train his workers and equip them with technology that will enable them to justify the increase in cost imposed by the minimum wage law, and no more. The net result thereof will be that each worker will be, say, 10% more productive in order to recoup the increased cost of 10%. The employer’s output per worker will be more, but his unit labour cost will be the same. In other words, he will spend just as much as before on putting out a single unit of production. The problem is that he will now over-produce by ± 10%, all other things being equal. The reason for that is the enforced increase in productivity. It must be remembered that the employer produces for the same market as before, in which there is a limit to the demand of the consumers whom he serves. The demand for his products will be the same, and he will therefore have to retrench workers in order to maintain his output at the same level as before.

Increases in productivity are good for the market, and in the long run create jobs – but then only if such increases in productivity lead to reductions in the unit labour cost – in other words if the employer can produce one unit of production more cheaply than before. If however the employer is compelled by law to recoup an increased cost imposed by law, the incentive is to improve productivity to the level that is necessary to recoup the imposed cost, and to get rid of workers.

The pro-lawyers mistakenly believe that by improving the lot of employed workers by force of law, we will all be better off. And that causes them to believe that if we continue digging this vast hole that is unemployment, hoping against hope that if only we dig hard enough, one day we will get out. We will not.

Myth no 3: Deregulation will lead to wage inequality
In similar vein to the “race to the bottom” myth, the argument is often made that the removal of protective labour law measures will lead to an exacerbation of South Africa’s problem of wage inequality. One of the possible benefits of such measures is, after all, is that they ensure greater social justice in the shape of greater equality of income, they reason. In other words: Although as the result of labour regulation we pay a price in terms of employment, at least we ensure greater equality of income, not so?

But just think about that for a moment: In principle nobody earns less than the unemployed. The more unemployed we have, the less will the bottom sections of the labour market earn.

So it follows that the more unemployed we have, the greater the income gap.

It therefore should come as no surprise that here is a close relationship between unemployment and earnings inequality, as appears from the graph:

Screen Shot 2014-02-19 at 10.47.28 PM

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But at least enforced minimum wages and the like should have the effect of compressing wages amongst the employed? At least that will serve the object of social justice, will it not?

First of all, a standard of social justice that measures only the equality of income those privileged enough to get jobs, is a doubtful notion of justice indeed. This immediately exposes the fallacy of this thinking.

But more surprising is that this seemingly axiomatic conclusion is one “that just ain’t so”.

What is particularly surprising in South Africa is that unemployment is associated with earnings inequality even among the employed:

Unemployment and earnings inequality amongst the employed

Screen Shot 2014-02-19 at 10.48.09 PM

Screen Shot 2014-02-19 at 10.48.21 PM

In her recent study which produced these figures, Fiona Tregenna (Tregenna: The relationship between unemployment and earnings inequality in South Africa, February 2009) concluded that:
“Our empirical investigation points to the centrality of unemployment to the understanding of inequality in South Africa. The decomposition of overall income inequality by factor source showed that earnings from work account for most of total income, and the inequality in households’ receipt of earnings from work account for almost 80% of overall income inequality.

We also observe a surprisingly close relationship between the trends in unemployment and in earnings inequality amongst the employed over time. This is interesting in that it suggests that – at least for the period under review and within the ranges of inequality and unemployment during that period – there might not be a trade off between inequality and unemployment as the dominant international literature would expect … Furthermore addressing the crisis of unemployment is vital if South Africa’s extremely high levels of inequality are to be reduced ...” (emphasis added).

Labour law is unlikely in South Africa ever to remove the problem of inequality of income. On the contrary, indications are that it is one of its major contributing causes.

If we seriously want jobs to grow, we need to take the thicket of regulation – both general economic and labour regulation that hamper it – far more seriously.

1 Economic Freedom and Economic Growth in US States (Federal Reserve Bank of St Louis)

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