In the 1990s, Paul Krugman, later to win the Nobel prize for his work on trade, wrote: ‘There is nothing that plays worse in our culture than seeming to be the stodgy defender of old ideas, no matter how true those ideas may be. Luckily, at this point the orthodoxy of the academic economists is very much a minority position among intellectuals in general; one can seem to be a courageous maverick, boldly challenging the powers that be, by reciting the contents of a standard textbook.’
Krugman wrote to explain comparative advantage, the idea that trade between two countries raises the incomes of both. It is a simple and powerful idea, first proposed by the David Ricardo and responsible for the massive expansion in global trade in the second half of the nineteenth century, but is also a surprisingly unpopular one. Why? Because it is intellectually unfashionable. Says Krugman: ‘Free trade … has some sort of iconic status among economists; so, in a culture that always prizes the avant-garde, attacking that icon is seen as a way to seem daring and unconventional’.
How valid this statement is about the South African labour market. Every economics student at university is taught supply and demand. Where the supply and demand curve intersect is the equilibrium price and quantity. A government regulation to fix the price – say at a price above the market price – will result in a shortage, as more things will be demanded than supplied. This is true for any good – from cars to cigars – but also for labour. Workers demand jobs while firms supply jobs. The equilibrium price in the labour market is the wage. A government-sanctioned regulation that fix the wage – like a minimum wage – above the market equilibrium means that there will be a shortage of jobs, in other words, unemployment.
This is all standard first-year economics. Yet the belief that a minimum wage will have no effect on South Africa’s already record-high unemployment rate is now deeply entrenched by both Krugman’s avant-garde intellectuals and opportunistic politicians and labour union leaders. Any attempt at debate is dead-batted. Proponents happily circulate articles that show a weak or even zero correlation between minimum wages and unemployment, disregarding the fact that these are often about workers in Seattle rather than Soweto. They argue that higher wages will result in higher levels of spending in the economy, boosting growth, but ignore the fact that higher wages must be paid be someone else, reducing spending by the same amount. And when they run out of credible arguments, they play the man, not the ball, labelling those hoping to debate the merits and demerits of minimum wages ‘apartheid apologists’.
This is a tragic state of affairs, for two reasons. First, there are credible reasons to have minimum wage legislation, and good research to back up the claim that not all minimum wages inevitably result in higher unemployment. But this requires a dive into the detail of each case. As economist Tim Gindling writes in a summary of literature on minimum wage legislation in developing countries, minimum wages can either increase or decrease unemployment depending on the characteristics of the labour market. Minimum wages target formal sector workers, but in most developing countries formal sector workers are a minority of workers and, importantly, not the poorest. How minimum wages affect the poorest therefore depends on things like the size of the informal labour market, the distribution of income and the available social safety nets.
A second reason why broader debate is necessary is that the impact of the new National Minimum Wage Act that was implemented from the first of January this year has almost entirely escaped discussion in the run-up to the May 8 national elections. The Act set a national minimum wage across all provinces and sectors R20 per hour per worker with two exceptions: agricultural workers had a lower rate of R18 per hour and domestic workers and gardeners an even lower rate of R15 per hour.
While it is clearly too early to know whether the Act did increase unemployment, one alternative is to turn to research about the impact of earlier minimum wage legislation. Here the results also require nuance: in some sectors, like agricultural and textiles, higher minimum wages seem to have had large negative effects on employment. This may be because these sectors had limited labour productivity growth in the past two decades. Higher minimum wages simply pushed the equilibrium wage above what employers could afford. This did not come as a surprise: National Treasury officials and most academic economists predicted that minimum wages will cause job losses, the same prediction they have made for the most recent legislation as well. But minimum wages did not lead to higher unemployment in all sectors, largely because employers assumed that the legislation would not be enforced. They have continued to pay their workers below the minimum wage, which has meant that they could retain most jobs. Even the South African government shirks the same high minimum wage: workers employed on one of the government’s expanded public works programme are entitled to a minimum wage of R11 per hour, almost half the minimum wage government expects the private sector to pay.
Ultimately, minimum wages can only do so much to lift the incomes of the poorest. If the minimum wage rise too quickly, without keeping track of labour productivity, employers will find alternatives, either by substituting capital for labour or by shifting production to countries with cheaper wages or higher labour productivity. Both will deepen the unemployment crisis.
Instead of minimum wage legislation that ultimately have limited power to affect a radical economic transformation of society, we desperately need innovative economic policies that boost labour productivity. Perhaps it is time for a courageous maverick to boldly challenge the powers that be. Weapon of choice? A standard economics textbook.