Implications of minimum wage
Dramatic rise in wages poses upside risk to inflation
RECENT
news suggests that Prime Minister Najib is likely to announce setting a minimum
wage on Labour Day (May 1). This is authorised under the National Wages
Consultative Council Act of 2011 passed by parliament in July last year.
Because of
the looming general elections, the announcement is likely to be construed as
politically motivated, but there are also important economic consequences of a
legislated minimum wage requirement.
The
minimum wage is likely to be set anywhere between RM800 to RM1,000 per month.
If we assume RM1,000, this would imply a significant 17% rise in the wages of
unskilled workers, which according to Malaysia's Employers Federation 2010
Salary Survey, are earning an average RM852 a month.
To put this in
perspective, it compares with the average increase of wages in the
manufacturing sector of only 6% per year.
This poses
an upside risk to inflation, in our view. First, overall labour productivity
growth, which has been slowing in the last few years to an average of 2.7%
(versus 5.3% pre-1998), is likely to substantially lag the potential increase
in minimum wages, resulting in a rise in unit labour costs.
Second,
while one could argue that the legislation only affects a certain segment of
the employed sector, in 2010 the share of private wage earners earning RM1,000
or below comprise nearly 50% of total employment, according to the Malaysian
Institute of Economic Research.
Given the
significant share, this is also likely to affect wage negotiations among higher
skilled workers, and could stoke higher wage expectations.
As is
common in other countries (e.g. Indonesia), minimum wages can be perceived as a
wage-setting mechanism (which sets a floor to actual wages) rather than just a
safety net for low-wage workers.
Finally,
given the current strength in domestic demand (indeed Bank Negara's annual
report suggests that domestic demand “will continue to be the anchor for
growth,”) firms are likely to pass on rising input costs, fueling CPI
inflation.
There are also
longer-term concerns:
● Minimum wages
could introduce rigidities into the labour market that may ultimately
structurally raise unemployment rates. We think part of the reason Malaysian
unemployment rates recovered quickly during the 2008/09 global financial crisis
is that wage flexibility allowed downward adjustment in wages rather than
employment losses during the downturn. Indeed, wages fell more sharply in
2008/09 than in the previous recession, and the unemployment rate recovered to
pre-crisis levels more quickly and stayed there until now. The legislated
minimum wages could reduce some of that flexibility.
● This could also
hurt external competitiveness, which, as we have argued before, is facing some
pressures that are not due to an appreciating real exchange rate. If a minimum
wage of RM1,000 is set, Malaysia's labour costs will be nearly twice the regional
average and will be the highest in South-East Asia except Singapore.
We understand that
the Government is fully aware of these concerns and has pledged to address them
by a broader set of structural reforms under Prime
Minister Datuk Seri Najib Tun Razak 's New Economic Model and the 10th Malaysia
Plan unveiled in 2010.
The problem,
however, is implementation has been slow so far and without more meaningful
progress, these concerns will likely persist. One key argument of the
proponents of the minimum wage is that this is supposed to complement these
reforms by imposing a hard constraint on firms to improve productivity and
reduce their reliance on low-skilled, low-wage foreign workers.
The risk is the
reforms lag the minimum wage implementation, and hence the argument fails to
hold, while external competitiveness could suffer.
The extent of the
impact will still depend on the level of the minimum wage set, and the enforcement
among firms.
While the latter
remains to be seen, for the former, we can draw on some findings from academic
literature to gauge the optimal level of the minimum wage, i.e. whether it is
high enough to improve living standards of wage workers but low enough to keep
competitive pressures under control.
A study by
the World
Bank suggests that a useful rule of thumb for developing economies is
that the minimum wage at the national level should be no more than 40% of
average wages.
By this
benchmark, a minimum wage set at RM1,000 for Malaysia seems appropriate on
average, though there is considerable variation across sectors. For instance,
it is around 41% of the current average in the manufacturing sector, but about
75% of the rubber sector.
In terms of the
near-term monetary policy implications, although headline inflation eased for
the fourth consecutive month in February to 2.2% year-on-year from 2.7% in
January, we see risks to our current policy rate forecast of a total 50 basis
points cut in the second half of 2012.
We think the risk of
Bank Negara remaining on hold for the rest of 2012 has already increased given
that in its recently released annual report, the central bank continued to
assess that “at the current level (3%) of the overnight policy rate, monetary
conditions remain supportive of economic activity.”
Minimum wages
implemented in May could provide additional upside risks to inflation, when
fiscal policy is highly expansionary and commodity prices are elevated.
Date : 29 March 2012
afternoon highlight (29/03/12/058/535)
