Inviting economists to a Xmas roast turkey dinner

Author: Andrea Beccarini Crescenzi
Published on Malta Today 22nd December 2016

Theoretically if we invite leading economists to a Xmas turkey dinner we may expect them to express different views on the subject of how best to address the phenomena of people falling into the poverty trap – perceived or real.  Most likely they will advise us to recalibrate the minimum wage; compute the base wage bringing in the typical needs of a family; redefine the index used as a base for the COLA mechanism and finally consider increasing productivity or GDP growth rate in the adjustment calculation.

It may be a coincidence that last week fate brought together two economists Lino Briguglio and Gordon Cordina to speak at an MCESD meeting where they submitted studies concerning the topic of poverty and whether this can be alleviated by a possible increase in the minimum wage.

Such studies have shown that an increase in the minimum wage can have both positive and negative effects on the economy, adding that when the increase is modest, there generally is a beneficial effect.

Among the benefits, both economists expressed the view that an increase in the productivity of workers, as well as an increase in their purchasing power, results in more spending.

It goes without saying that any increase in the minimum wage should be motivated and quantified using objective economic measurements, further guided by a dialogue with civil society and other social partners, and “future proofed” so that they allow changes.

The obvious question to ask is; can employers afford to raise wages?  The answer is complex since we know that most employers, particularly SME’s, cannot afford to pay higher wages, leading us to ask what type of government intervention will help them to become more innovative, earn higher profits and export more.

Ominously it looks like something must give since without a decent wage people cannot survive in today’s competitive environment and consequently face the risk of sliding into a bottomless poverty trap.

Caritas studied the plight of the poor in Malta in late 2012 and again in 2015. It found that the same basic basket of goods and services (no car, no foreign holidays; only the very basics) bought by a typical low-income family of two parents and two children cost €811 more last year than it did three years before.

But in those three years, wages paid to lower income groups increased nowhere near €811 a year; weekly increases of 58c and two of €1.75 come to just €212 a year. It follows that those who were already at risk of poverty in 2012 went deeper into poverty by 2015.

Obviously, those who were just getting by are now in poverty. What Caritas clearly found was that the real cost of living of the lower income groups increased by 7.6% over those three years, while government’s figures say that between late 2012 and late 2015 inflation was just 2%.

Government itself studied real wages between August 2015 and last August.  It was an interesting exercise published in the Economic Survey with the 2017 budget and one may conclude that workers in the medium- and lower-income groups are not keeping up even with official inflation, let alone real inflation.

It is intriguing to note how Briguglio’s presentation starts with an explanation about the COLA mechanism: it is a social contract acting as an adjustment based on the RPI (Retail Price Index), applied to all salaries as a flat rate not regarding their level: in this way, lower wages benefit more than higher ones and the minimum wage earners benefit the most.

Between the 22 European countries that use this system, Malta’s minimum wage ranks 10th in nominal terms (€168 per week) and 9th in PPP (power purchasing parity) terms (€209 per week), being the 46% of average wage. This percentage is however decreasing since 2007, indicating that the changing in higher wages is faster (thus widening the divergence).  Pros and cons are mostly ideologically-driven: adherents of the social contract claim that the COLA system protects workers and has rendered Malta almost “strike free”, while the other side claims that it impacts country’s competitiveness.

The IMF suggests linking the COLA mechanism of the productivity gains, rather than simply adjusting it to the inflation pointing out that also inequality is a threat to competitiveness (if workers lose purchasing power, the economy depends increasingly from the external demand).

On the other hand, the EU in 2011 observed that the adjustment to the minimum wage was hampering the competitiveness of the labour-intensive sectors.  It is interesting to focus on Briguglio’s hypothesis which highlights the main issues of economic theory regarding unemployment: setting up a minimum wage is the same as creating a price floor.

If the market price (market wage) should be lower than the price floor, this is likely to create an excess of supply (workers willing to work without enough workplaces): unemployment.

However, there is no certainty about the fact that a minimum wage always creates unemployment:  for example, this doesn’t happen when the minimum wage is set up below the market wage.

Another theory considered is that “insiders” (people already working) could enjoy advantages when compared to those seeking a job, the “outsiders”. To sum up the mainstream economics theories, Briguglio says that increases in wages cause mixed results, more likely to be negative.

Finally, he confirms that there is no empirical evidence that wages and labour demand are negatively correlated: in most cases, and Malta is one of these, higher wages result in higher production and less unemployment. This is a greatly discussed point in recent development of the discipline: old theory says that if labour cost is higher, employers are less willing to hire the workers with the least marginal productivity; but since the market prices (and wages as well) are usually “sticky”, the short-term effect is very poor.

Stickiness (or nominal rigidity) means when prices adapt slowly to the market forces. The recognition that prices are often sticky has been the base theory for the New Keynesian Economics (not to be confused with Neo-Keynesism nor Post-Keynesism), which represents the current progressive wing of the mainstream economics (in America it is supported by ‘liberals’, in Europe it is supported by left reformists).  As a result, more and more representations of equilibrium models started recognizing that imperfect competition is the rule and not the exception.  Once again, according to mainstream economic thinking, the setting of the minimum wage is often considered to negatively affect competitiveness of firms.

But again, as Briguglio showed in a recent study (published in 2014 with Melchior Vella), an increase in the minimum wage could be offset by productivity growth, possibly leading to a reduction in unit costs. This effect, not expected in classical economic theory, is due to a number of factors that weren’t taken in account: for instance, well paid workers are more willing to work and so they are more productive.

Moreover, well-paid workers will sustain the demand for the products they’re producing. Threats to competitiveness are rather arguments used by companies which produce in poor countries and sell in rich countries.  But once rich markets are saturated, and labour costs are compressed everywhere for competiveness’s sake, the world economy is stagnating due to an excess of supply: hence financial instability and creeping deflation worldwide.  The middle of the road proposals are the obvious ones that is linking the minimum wage to the average (or median) wage, or to the productivity, or to the GDP growth.

In conclusion, economists gorging food at our hypothetical dinner table certainly do concur about the need to periodically align minimum wages and grant periodic increases so long as employers can afford the measure.  Before reaching for dessert our invited guests are unanimous that maintaining the status quo is not an option.

Author: Andrea Beccarini Crescenzi
Published on Malta Today 22nd December 2016
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