Op-ed: Case for higher minimum pay is dangerous | Sunday Times

29 Oct 2018, by CDE
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It’s dangerous that the jobs summit retreated into a fantasy world, by Nicoli Nattrass and Jeremy Seekings.

The framework agreement from the jobs summit endorses the monitoring and enforcement of the new national minimum wage. Ignoring the trade-off between wages and employment, it argues that this will “stimulate aggregate demand in the economy through wage-led growth”, implying that such growth will also create jobs. This is a dangerous fantasy.

Believers in job creation through wage-led growth make three dubious assumptions.

The first is that employers can remain competitive by improving efficiency without shedding jobs. In “tradable” sectors that are exposed to international competition, firms are already under pressure to increase efficiency – they don’t need to be prompted by higher wages to do so.

Much more likely, a rise in the minimum wage will result in labour-saving technological change and some firms will go out of business. The result will be job destruction, especially in labour-intensive sectors where labour costs account for a large proportion of total costs.

The second dubious assumption is that higher wages will boost consumer demand to such an extent that profitability and investment remain buoyant. This is most unlikely in an open economy like SA’s where consumer demand sucks in imports (even low-income consumers purchase clothes from Asia and chicken from the US) and higher wages drive up prices, thereby undermining competitiveness in tradable sectors.

Higher wages can help boost nontradable (domestic) services such as hairdressing and restaurants, but this will be insufficient to compensate for the loss of international competitiveness. The likely consequence is a fall in profitability, investment and growth.

SA’s economy is profit-led, not wage-led. Capital accumulation relies on corporate savings and capital inflows (the government and household sectors are typically net borrowers). And, as emphasised by the international expert panel on South African growth chaired by Harvard professor Ricardo Hausmann in 2006-2007, SA’s “binding constraints” are on the supply side, notably skilled labour shortages, infrastructural bottlenecks and investment finance – not the demand side.

Yet the zombie notion that the South African economy is demand-constrained and can be kick-started by higher wages refuses to die.

For example, Cosatu favoured the introduction of a national minimum wage at a relatively high level, justifying it with reference to the Brazilian case, the so-called “Lula moment” when economic growth, driven primarily by the commodities boom, benefited also from rising minimum wages and linked social security payments during president Ignacio Lula da Silva’s second term of office (2006-2010).

There is evidence that rising minimum wages and social security payments in Brazil helped cushion the impact of the global economic crisis, create jobs and reduce poverty. But in sharp contrast to SA, this occurred in the context of very low unemployment and in an economy where investment was financed largely from domestic sources. South Africans, by contrast, borrow to finance consumption – and this trend worsened after apartheid.

Two published macroeconomic analyses of the economy using simulations and data from the 1990s (by Gibson and Van Seventer in 2000) and 2000s (by Oranan and Galanis in 2013) concluded that wage-led growth was not feasible in SA.

Both predicted that increasing the wage share would undermine investment, growth and employment, and generate balance-of-payments problems. A subsequent simulation by the National Treasury (by MacLeod in 2015) came to the same conclusion, notably that the South African economy “is profit/investment driven” rather than “wage/consumption driven” because profits are the main source of funding for investment and wages, and because a significant amount of consumption generated by wage increases gets spent on imports.

The Treasury model predicted that if a national minimum wage was set at 60% of the median wage (that is close to the minimum sectoral determination for domestic work) and rigorously enforced, it would result in a 2.1% fall in employment and a 2.5% fall in output.

Two Cosatu-aligned macroeconomic modelling projects, however, continued to present an implausible alternative narrative that higher minimum wages would drive growth. The models assumed unrealistically that higher minimum wages would boost productivity, while leaving employment largely unchanged, and that any negative impacts on profitability, investment and the balance of payments would be insufficient to derail wage-led growth. Yet even in these dubious models, unemployment remained stubbornly high, implying that even if higher wages could fuel economic growth by boosting demand (which is unlikely), this will never amount to serious job creation. For that, a much more labour-intensive growth path is required.

Those presenting wage-led growth as a means of overcoming unemployment make a third dubious assumption, that consumption-driven growth will improve the employment elasticity of growth.

Even in the consumption-led growth of the 2000s, SA’s employment elasticity of growth remained low, meaning that economic growth did not result in proportionate job creation. Trying to stimulate economic growth through raising wages is likely to reduce it further. In other words, even if the economy was stimulated to grow faster, the benefits would not reach the unemployed and the poor.

Wage-led modelling narratives depend on implausible assumptions and are inconsistent with historical trends in SA.

They offer us the rosy fantasy that, this time, things will be different: higher wages will somehow translate automatically and instantaneously into higher productivity, implying that savings and investment will not be undermined.

Such narratives ignore the negative impact on profits (and thus on investment), choosing instead to emphasise the benefits of lower wage inequality but without confronting the fact that unemployment remains high and the chances of less-skilled workers ever getting jobs decreases.

Wage growth in profit-led economies like SA typically benefits skilled workers because it encourages mechanisation: skilled labour is a complement to capital-intensification, whereas less-skilled workers lose their jobs.

It is depressing that the jobs summit retreated into the fantasy of wage-led growth rather than confronting the challenges of making the economy more labour-intensive.

• Nicoli Nattrass, is a professor of economics at the University of Cape Town and Jeremy Seekings is a professor of political studies and sociology at the University of Cape Town.