Labour Vanguard

We can’t grow SA with poverty wages, write Gilad Isaacs and Ben Fine

In 1993, Princeton researchers David Card and Alan Krueger turned conventional wisdom on its head. Their now famous study showed that increasing the minimum wage in New Jersey, US, did not have negative employment effects on that state’s fast food industry.

The debate over the future of South Africa’s new national minimum wage legislation, which is heating up, would be strengthened by a consideration of the research conducted over the past two decades. Much of this runs, surprisingly, in the opposite direction to “common sense”.

The main “common sense” argument is that by imposing minimum wages, one artificially raises the price of labour away from its “market-clearing” level and higher unemployment results.

The most comprehensive review of the impact of minimum wages in South Africa – which since 1999 have been implemented in 11 different sectors of the economy – was conducted by researchers from the University of Cape Town and Cornell University in New York on five sectors: retail and wholesale, domestic workers, forestry, taxi workers and private security. The study found no negative impact on employment resulting from the minimum wage.

In three out of the five sectors, workers emerged materially better off. In other studies on the agricultural sector, it was found that institution of a minimum wage did negatively impact employment.

Case studies similar to those of Card and Krueger – particularly those studies contrasting labour markets experiencing a minimum wage increase with a carefully chosen comparison – tend to find that minimum wage increases have little or no effect on employment levels.

The same holds for a number of meta-analyses – studies that draw conclusions out of a survey of the literature by combining results from a range of studies. The respected 2009 meta-analysis by Hristos Doucouliagos and TD Stanley incorporating 64 minimum wage studies that covered 1 474 individual estimates showed no support for adverse effects.

Notwithstanding the variable impact on employment, minimum wages have overwhelmingly been found to decrease poverty and inequality.

How can the evidence on labour markets contradict the supposedly “common sense” theoretical premise that, like the market for fish, an increase in price will mean lower demand?

Neoclassical economic theory thinks of labour markets as akin to other markets, governed by the iron laws of supply and demand, in which, if left undistorted, a price will be reached at which everything in the market will be sold. In the same vein, so the theory goes, no involuntary unemployment other than that caused by excessively high wages should exist.

But labour markets are not like other markets and these laws do not determine the wage level, and the wage level is neither the only, nor the key, factor regulating employment levels.

Unemployment is present even when wages are low. In South Africa, large-scale unemployment began in the 1970s and, by 1994, was already at 30%.

Regarding wage-setting, employers may not simply accept the hypothetical “market price” of labour, but are sometimes – because of structural power imbalances – able to force wages below this. In this instance, wages may actually be below what it costs the worker to live and the state must pick up the bill or the worker ends up hungry, sick or homeless.

On the other hand, because wages must, to some extent, support the worker (at standards set by social norms) there’s a floor beneath which wages will not fall despite high unemployment indicating “excess” labour supply.

Wages are themselves an outcome of the type of investment and jobs created, and shaped by class, conflict, power and other social factors. Wage levels may be one consideration in levels of investment, but the evidence indicates there is no unidirectional causation between wage, investment and employment.

The traditional low-wage growth path in South Africa is exhausted as both an economic and political strategy. In the context of mediocre growth and rising inequality over the past two decades, workers are demonstrating that they are ever less willing to tolerate poverty wages.

Wages must be set to target productivity and efficiency – evidence suggests that due to insecurity, labour discontent and the inability to live a healthy lifestyle, low wages do not necessarily achieve this.

There are good reasons wage increases could expand, not reduce, both employment and growth. For instance, boosting household income can increase demand in the economy, spurring growth and employment in other industries.

These positive effects are not guaranteed. Rather, they point to the necessity of taking a broader view of how the economy – and labour markets within it – functions as a whole.

The national minimum wage is a step towards an alternative growth path. But it must be accompanied by other initiatives, such as industrial policy that sees South Africa create jobs in sectors that can sustain moderately higher wages, and grow sectors that can benefit from, and contribute to, increased domestic demand.

We should view with scepticism any claims that there is a simplistic mechanical link between wages and levels of employment. The stakes are too high for such distortions to fly in the face of logic, evidence and need.

Isaacs is a PhD student in economics at the University of London. Fine is professor of economics at the University of London