A myopic view of wages

When workers’ income can’t make both ends meet, or when their take home pay can no longer take them home, something’s got to give. Often, the common view takeb by sectors is to increase the wages. This is often a myopic view and usually results in unintended adverse consequences to the intended beneficiaries.

The beneficiaries

Last July 1, 2010, the NCR Wage Board gave a P22 increase in workers’ minimum wage to P404 per day. That minimum wage increase benefited only some 2.2 workers of 38% of all those employed in the formal sector of th economy.

That grant did not provide any relief at all to the unpaid family workers, own-account workers, household workers, government employees and government-owned corporations and workers in the so called underground economy, which number is roughly 33 million, out of the 38 million workers in the workplace today.

Unintended consequences

For businessmen and employers, the consequences are simple but severe. The P22/day increase in the minimum wages in 2010 translated into roughly P22 billion in annual incremental expenses in wages, distortion adjustments, and wage-related benefits for the 2.2 million workers. Even as businessmen and employers are still reeling from the heavy burden of last year’s wage increase, the danger of additional burden in 2011 is imminent as Regional Wage Boards are lately deluged with petitions for another round of wage increase. The law does not allow wage adjustments to me made within a year from the last wage increase (July 1, 2010), unless there is a supervening events. I do not wish to debate whether there are such events or not.

When wage increases are mandated, there are unintended consequences whose ripples are felt by all sectors of society. When wages are raised, the cost of production and of goods sold tend to increase as well. This results in higher prices of prime commodities needed by the masses. The masses, especially those who do not receive wage adjustments, are the most badly hit by the adverse effects of the wage increases. Remember that of the 38 million workers in the workplace, only 2.2 million are minimum wage earners and 33 million are in the informal sector or in government and are therefore not covered by the wage adjustment at all.

Nature of minimum wage

I remember how my good friend, the Honorable Ciriaco Lagunzad III, Executive Director of the National Wages and Productivity Commission, explains the need for a minimum wage. He said that the minimum wage is “rooted in the basic concept of providing workers with safety net protection against unduly low wages. Such minimum wage rates shall therefore be confined as much as possible to protecting the lowest paid workers from the vagaries of the labor market.”

In simple words, setting the minimum wages provides a safety net for the entry level or lowest paid workers, such as new entrants to the labor force, unskilled and inexperienced workers. For as long as the minimum wage is maintained a a competitive level, more workers would have a greater chance to land a job in a labor-surplus economy like the Philippines. It is easier to promote Filipino labor when it is of high quality and reasonably priced in the global market. When the minimum wage is raised far beyond the safety net level and loses its competitiveness in the global market, workers with low level of skills will have very little chance, if at all, in competing with more skilled workers in finding decent jobs in the formal sector.

Wages and productivity

To be viable, wages must be exchanged with creation of value that customers are willing to pay for. Often, businessmen and employers expect a certain level of productivity in exchange for workers’ wages. Absent this exchange, wages cannot be sustained or viable. Furthermore, high wage increases not coupled with productivity will discourage the use of labor-intensive operations. The usual consequence is that industry will tend to find automation the more viable option. Capital intensive technology and deployment of a core highly skilled workforce will prove more viable than hiring many less-skilled workers with high wages.

When the cost of labor as a factor of production is unduly raised by mandated wage adjustments without a corresponding increase in productivity, it will cost more to produce the same quality and quantity of output. Businessmen are often forced to pass on additional cost to the market. This results in an uncompetitive position in the market. When companies could not pass on the increased cost in labor to the market because of the competition offered by lower cost imports or smuggled products, they are often constrained to either reduce their workforce, adopt labor-saving techniques to reduce their costs, or simply close shop.

Effects of wage increases

While high wages are usually welcome by workers, the effects is usually temporary. In reality, the usual alleged reasons for granting wage increases are temporary – such as high prices of gasoline products or increase in transport fares. Often, when situations normalize, gas prices go back to more reasonable levels and transport fares are reverted to earlier levels. Permanent wage adjustments, therefore are not the appropriate solution, as they permanently increase the fixed cost in doing business and bring up the prices of prime commodities. Wage increases tend to spur inflation. When wages can no longer bring food to the table, increasing wages tend to put food beyond reach of those who are not benefited by wage adjustments. Reducing the prices of food through government subsidy, increasing food production, or other means might be more viable and permanent solutions.

Over the years, the formal sector has been losing business establishments to the informal sector. High wages tend to exacerbate the shrinking of the formal sector and decimate micro and small establishments which do not have the financial resiliency to cope with mandated wage adjustments . This is especially true if wage adjustments are simply seen as a safety net and devoid of a corresponding increase in productivity. During the period 1999 to 2008, at the onset of the Asian Financial Crisis, 65,000 business establishments moved down from the formal sector to the underground economy. In the process, nearly half a million jobs were lost.

The burden of wages

It is interesting to note that that the burden if minimum wage adjustments is borne not by the large companies employing 200 or more employees. Large companies number roughly 3,000 in the Philippines today, and account for roughly 32% of employees in the formal sector. On the other hand, the small and medium enterprises (SME’s), account for roughly 60% of total employment in the formal sector. The 2.2 million employees who are minimum wage earners are inthe more than 600,000 micro enterprises, close to 40,000 small enterprises, and close to 20,000 medium enterprises. The micro-enterprises and the SME’s bear the burden of wage increases. Many of these smaller companies do not have the resiliency or viability to absorb additional wages, especially where there is no added value received in exchange.

In terms of productivity, the Philippines ranks eleventh among 13 Asian countries today. Among comparative economies (China, Thailand, Indonesia, Vietnam and Cambodia), the Philippines has the highest minimum wage – roughly $9.20 per day, compared with Vietnam’s $1.94 and Cambodia’s $1.67.

Undue increases in minimum wages will tend to discourage foreign and domestic investors from doing business in the Philippines. Foreign investors usually have a score card where they rate countries for competitiveness as a preferred destination for foreign direct investments (FDI’s). As we write today, Thailand usually gets 10 times the FDI’s that come our way, and Singapore more than 20 times. Wage adjustments will worsen the situation. The usual equation for job creation has not changed; it is INVESTMENT EQUALS EMPLOYMENT.

This might sound simplistic. It is desirable to have jbs and high wages. But at crunch time, when one has to choose which one to have, it is usually sound to choose the job. –Ernie Cecilia, Philippine Daily Inquirer