The minimum wage debate

Tue, Jul 1st 2014, 11:48 AM

The basic principle that underlies the minimal wage is that workers should be treated fairly and compensated for their contribution to the businesses that they work in. Usually, workers are compensated based on their productivity which, in turn, depends on their level of education, knowledge and work ethic. This is why in each business, the level of compensation that each worker receives is commensurate with his or her level of productivity. Workers' compensation is also influenced by the different skill set requirements, the supply and demand for labor, the overall profitability of a business and the monopolistic status of a business.
The more productive any business is, the more money it makes. In most countries, business earnings are directly related to the state of the economy, and thus, there is a direct relationship between business earnings and GDP. Business earnings are a manifestation of the total productivity of the business and GDP, as the name implies, is the sum of the productivity of all businesses in a country. As a general rule, the growth in earnings in any business cannot outpace the GDP growth rate.
Generally, the profits of each business entity are shared between business owners (shareholders), the management, the workers and the government (in the form of taxes). The question is, in any given year, to what extent should the workers share in the profits of a business. This is sometimes referred to as the balance between capital (owners) and labor (workers). Ideally, workers should be compensated based on their contribution to the overall productivity of a business. However, in most countries over any period of time, this balance can fluctuate in favor of either capital or labor.
In the U.S., there has been a large disparity between the compensation of management and workers to the point where, in some cases, management compensation is 300 times that of the average worker. There has been much debate as to whether this level of management compensation is fair or an example of gross inequality and greed. Really, the only way to justify such a disparity would be to estimate the productivity of any given CEO, compared to an average worker.
Although some people may be envious of the profits made by business owners during good economic times, there is no reciprocating sympathy for owners during hard times when they may actually lose money. Owners take the risk to start a business and, depending on the success or failure of the business, they either make or lose money. However, irrespective of economic conditions, the workers who have not taken any risk, expect and should be compensated for their contribution. One of the problems with the unions in The Bahamas is that often, when they are in negotiations concerning workers' compensation, they appear to be insensitive to prevailing economic conditions and the level of productivity of the workers.
On another level, there is always the question as to whether the government's share of business earnings, otherwise known as taxes, is fair or equitable. And this always leads to the age-old question as to whether businesses are paying their fair share of taxes or whether they are being over-taxed. I think it's probably fair to say that businesses in The Bahamas are under-taxed and somewhat inappropriately taxed by government as a percentage of their profits. But on balance, because of core inflation, their effective tax rate is exceedingly higher than their counterparts in the U.S.
Thus, there is an ongoing four-way struggle for the distribution of business earnings. However, at any point in time, there are a number of forces at play which ultimately determine business wealth distribution. The government determines the level of business taxes and, thus, its share of the distribution. Businesses that have a global presence have the option of moving their operations to another lower tax jurisdiction when faced with high levels of domestic taxation. But governments can also impact business wealth distribution through policy initiatives that favor industry over households, as is the case in China and Germany. In these countries, the distribution of wealth is very much in favor of industry over households, and thus employees' share of productivity is limited by government policy.
Over the past five years, in the U.S. there has been a tremendous amount of attention paid to management compensation of business/corporate executives, especially those in the financial services sector. The problem in this case is that the compensation of the executives is usually determined by the boards of directors of the companies, who are usually appointed by the CEO and are, often, personal friends. The problem is that shareholders have no say in the matter and thus the system has been abused. In Switzerland, however, laws have been passed that limit the compensation of CEOs to a certain multiple of the average worker.
In the case of the average worker, compensation is primarily determined by four factors: inherent productivity, government policy, inflation (consumer price inflation and core inflation) and the existence and strength of the unions. I have already discussed the impact of productivity and government on labor compensation, but the impact of the two types of inflation is equally important. For example, when the economy is going well and there are low levels of unemployment, workers have more leverage over owners and options. In this case, employers, usually, have to raise the wages of employees which, in turn, increases their buying power which leads to more demand in the economy (more consumption), which leads to an increase in prices, which leads to a higher cost of living, which then leads to workers demanding higher salaries. Of course, the opposite cascade occurs during an economic downturn, such as now is the case in The Bahamas.
Core inflation
Core or structural inflation has an even greater impact on the effective income of workers. For example, in The Bahamas, even though the consumer price index (CPI) has been reasonably moderate, running around two percent, the level of core inflation has been horrendously high. The primary causes of core inflation are the high cost of energy, the high cost of money (high interest rates), the high cost of real estate and real estate transaction costs, exchange control and the tax structure (import duties). Core inflation has essentially reduced the real incomes of all Bahamians and reduced our national productivity (GDP) and thus also our global competitiveness.
Another way of looking at this is to compare the average worker's income in The Bahamas, which is $16,500, to the GDP per capita which is $22,500. This disparity would imply that there is productivity gap in dollar terms of some $6,500 between the average income of workers and their productive input into the economy. Moreover, the living wage in The Bahamas is around $45,000 per person. The difference between this figure and the average worker's annual income of $16,500 is $29,500. This figure is representative of the impact of core inflation on the income of workers. This difference is also the reason why the average Bahamian is forced to beg, steal and borrow in order to sustain him or herself. Notice also that the primary reasons for core inflation were energy costs, the cost of capital, real estate exchange control and the tax structure. This would imply that every year in The Bahamas there is a massive transfer of wealth from both the workers and businesses to the oil wholesalers, the banks and the government. This, in turn, has significant economic consequences as both the oil and bank related wealth transfers are expatriated each year, which means that these funds are not available to grow the local economy and thus provide the opportunity for more employment. The wealth that accrues to government is seldom used in a productive manner that creates productive employment.
The third factor that helps to determine the income of workers are the unions. The unions' primary role is to negotiate on behalf of the workers to ensure that they are paid fair wages and receive all of the associated benefits. For the most part, Bahamian trade unions have done a good job in negotiating on behalf of their memberships for salary increases and benefits. However, in some cases there has been no associated commensurate increase in the productivity of some workers with the increase in salaries and benefits, and this has had a stifling impact on certain businesses, especially the fast food industry. In aggregate, union leaders could have better improved the standard of living of their membership had they pressed government to implement policies that could have reduced core inflation.
Over the past several weeks, most of the discussion about the minimum wage has been primarily focused on the two opposing traditional, but somewhat one-dimensional views, on the impact of changes of the minimum wage level on the economy. Those (government and the unions) in favor of an increase, argue that increasing the minimum wage will improve the standard of living of workers. This view is supported by the thought that the marginal propensity to spend money is far greater for low income workers compared to higher income workers. This will, in turn, increase overall consumption in the economy and thus all businesses will be better off with a corresponding increase in GDP. Those who hold this view are not wrong about the economic consequences, but like President Obama they often confuse the minimum wage with a living wage, and as described above the two are quite different.
Opposing argument
The opposing argument is that, with the introduction of VAT, and potentially, a new healthcare tax and a mandatory pension scheme, businesses will be unable to bear the added burden of these expenses. They further posit that with an increase in the minimum wage, owners will be under pressure to increase the salaries of existing employees, and as a result, will be inclined to release some of their current employees and will potentially hire fewer future employees. If the later two outcomes were to occur, this would result in less future consumption and thus a decrease in GDP. Moreover, they speculate that during an economic recession, there are many people who might be willing to work for a lower wage, but because the employers cannot by law pay this lower wage they cannot be employed.
The overall impact of these opposing economic views depends of course on what percentage of the work force is impacted by any change in the minimum wage level, the state of the economy and the level of unemployment. Estimates vary as to how many employees would be impacted by the increase in the minimum wage level, but the consensus of opinions is that there are about 40,000 people who are currently earning less than the proposed $7 per hour. I would guesstimate that most of these individuals work in the food services (restaurants and fast food establishments), housekeeping and groundsmen services, or as gas station attendants or in the underground economy. If one assumes that each of these persons is working 40 hours per week, and the minimum wage is increased by $3.0 ( $4.0 to $7.0) then the collective annual payroll of businesses would be increased by approximately $250 million. The impact of a mandatory increase in payroll of this magnitude, especially during the current economic recession, could be the death toll for many of the aforementioned businesses. None of these businesses have the advantage of being a part of a monopoly or oligopoly, and thus cannot increase their prices to offset the increase in expenses associated with the increase in the minimum wage. Furthermore, in many instances like the gas stations and the fast food industries profit margins are very thin and any increase in expenses would certainly result in closure and a further increase in unemployment. The underground economy would not be impacted, because being out of the formal system, underground owners would not have to comply with the new policy. Paradoxically, there might be an increase in the supply of labor available to the underground economy because there could be so many persons desperate for work who might not be employed because of the increase in the minimum wage level, many who are prepared to work at the present minimal wage but cannot find jobs in the formal economy and those who will be released from the formal economy because of the increase in the minimal wage. The net effect of this would be to drive down wages even further in the underground economy.
Not the desired impact
Thus any increase in the minimum wage given the current set of circumstances would not have the desired impact of increasing the incomes of workers, but would lead to an increase in unemployment levels and a decrease in the aggregate (collective) income of workers. The increase in unemployment would result in more welfare payments, fewer National Insurance contributions (payments) and more crime. This, in turn, would result in lower levels of national consumption, a decrease in GDP and an increase in the debt; GDP and the negative economic cascade associated with this.
However, if the government were to focus on reducing core inflation then there would be a transfer of wealth from the banks, the oil wholesalers and the government to households and businesses. This would result in a positive economic cascade because there would be an increase in the real income of workers at all levels, all businesses and government. Moreover, there would then be more consumption, investments and new businesses resulting in an increase in GDP and a reduction in the debt to GDP ratio.
There are many factors that determine the wages and incomes of all of the stakeholders in any economy. When any change is contemplated, those contemplating the change must carefully review the possible intentional and unintentional consequences of such change on the overall economy. To a large extent it's a balancing act between what is fair and equitable and what is economically feasible.The question is will government implement the increase in the minimum wage without seeking any local advice on all of the possible economic consequences? If it's management of VAT and the numbers industry is any indicator, then I would assume that they will consult with at least three foreign economic consulting groups, two multinational entities, and some $2 million later in expenses, come to the conclusion that this is not the most opportune time to take such action. But, true to form, having put the proverbial political foot in their mouth, government leaders will still proceed forward with their plan and consequently further increase the number of business and home foreclosures, raise unemployment levels and further increase the debt to GDP!
o Dr. Jonathan Rodgers is a Bahamian opthalmologist, businessman, and author of two books on the Bahamian economy, "The Bahamian Dream" and "Is it really better in The Bahamas for Bahamians?"

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