Unsustainable compensation model

In the Philippines and elsewhere, employees are paid a salary to compensate them for the work that they do for the company. However, in the Philippines, annual minimum wage increases mandated by the government have interfered with competitive market forces. Over the years workers have come to expect that every year, regardless of their performance or the performance of the company, they would get a salary increase. This one way ratchet of ever increasing salaries and benefits for the workers is actually protected by law which does not allow for any diminution in salaries or benefits.

A double whammy

The difficulty, if not impossibility, of firing people for poor performance or when the company or certain portions of its business is not doing so well, coupled with the mandated increases in wages and benefits, is a double whammy that has taken its toll on businesses in the Philippines. We have lost our competitive advantage in various areas where we used to have an edge, resulting not only in the closure of several companies but the total collapse of entire industries. This has led to massive unemployment and necessitated the need for 11 million Filipinos to go overseas to look for a job, just to provide for their families.

Certainly, the labor policies and compensation system that our government has chosen to impose upon us is not a sustainable model. It definitely has not benefitted the workers since we have one of the highest unemployment rates in the region and the second-highest migrant worker population in the world. Neither has it improved the standard of living for the common laborer. On the side of the employers, they have lost their ability to compete both here and abroad, forcing businesses to close down or relocate to other countries.

Structural changes needed

Given this dire situation, structural changes must be made by the government in moving away from this unsustainable compensation model. What then are the available alternatives? A system where there is a low base minimum wage that is set and allowing market forces to dictate the correct equilibrium has been employed by more successful and highly competitive countries both in the developed and developing economies. Having a low minimum wage stimulates the hiring of workers and allows businesses to have a low barrier to entry. This in turn provides a stronger domestic consumer base and companies to be more competitive.

Successful businesses and industries not only stimulate the economy, but also attract new investments which creates competition. Once there is competition, companies will have to adjust their salaries and benefits to retain their best workers, providing the workers the incentive to do their jobs well and be compensated appropriately. In short, compensation is tied in to good performance of both the worker and the company, which is totally the opposite of where we are today in that salaries are increased under the guise of increasing minimum wages, regardless of the performance of either the worker or the company.

New models

Compensation should be tied into not only the performance of the worker but also the ability of the company to pay. Perhaps rather than having salary increases or even a minimum wage there should just be a profit-sharing scheme or a productivity based compensation. In a profit-sharing scheme, a certain percentage of the company’s profits are shared amongst the workers. The more profitable the company is, the more there is to share among the workers. This way, the workers have a direct interest in seeing to it that the company is profitable. Of course, if the company is not profitable, there is nothing to share.

Productivity-based compensation is also a fair way of providing the correct incentive for those that do their jobs well, since what they get is directly related to their output or contribution to the company. Perhaps this is a better compensation model since the primary determinant of the amount of wages a worker gets is the worker himself. This will prove to be popular to the more capable and hardworking employees but not to those that do not take their jobs seriously. This is why it is our best workers that are able to do well in jobs abroad, sometimes leaving us with the less talented and less desirable ones. This has led to our rather unfortunate situation where the most militant workers are the ones that do not have the right talent or work ethic.

Our only hope is that the government is able to get rid of this scourge of unethical workers by allowing market forces to dictate salaries and wages as well as giving back businesses the right to fire these undesirable elements from the labor force. Otherwise, we are all doomed like a moth spiraling toward the flame.

George S. Chua is a professor of Finance at the De La Salle University Ramon V. Del Rosario Sr. Graduate School of Business. He may be contacted at chua.george@yahoo.com.