Labor welfare: minimum wage vs labor productivity

My column last week said that if we want Philippine membership in RCEP to succeed in bringing immense benefits for our nation, our policy-makers (led by the President) must focus on amending the restrictive economic provisions of the Philippine Constitution on foreign direct investments.

Labor market reform component. I deleted from that essay another key policy reform that I had wanted to emphasize. It required further explaination, and there was no more space.

It started with the quote below:

“…If there is another major reform that we must pay attention to, it is that labor market reform be centered on making labor productivity as the driving force behind wage reforms…”

It is a topic of great importance. It is an important aspect of understanding how wages and incomes rise in an economy that is growing from the expansion of economic activity.

In fact, on the day when my Crossroads column was published, the Philippine Star’s business section headlined (March 1, 2023): “Wage hike harmful to economy – NEDA.”

The business story reported on the question posed by a Congressional Committee on Appropriations member as he listened to a briefing on the development budget. He asked the NEDA Secretary if the government would increase wages as a solution to current rising prices.

Here was how NEDA Secretary Arsenio Balisacan, an economist whose work on poverty and development is highly respected, replied: “We can’t do that. It does more harm to the economy in the longer term than it benefits.”

He further explained that the best way to increase wages in the country is to expand economic activity through more investments that complements labor. Investments can make the demand for labor to rise faster than the  supply of labor. If wages rise not because of high demand for labor and improved productivity, our exports become more expensive and less competitive. That is not helpful. (He further outlined how the current inflation which is related to the food sector could be dealt with through raising agricultural productivity.)

A lot of my columns in Crossroads have dealt with the issue of labor employment, the welfare of the poor, and in general, the labor market policies in relation to development.

Current wage policy. A summary of current policy is this: Wage-setting has been a case of government intervention on the issue of “fairness” to the worker who is employed in organized industry: in the big industries, in government, and in manufacturing and the services. This philosophy of wage setting was the result of foreign advice on the minimum wage in 1951.

Most countries in East Asia whose success in economic development has been historically astounding – starting with Japan, South Korea, Taiwan – emphasized investment policies and resisted minimum wage legislation. When they finally did, they made sure it was “minimum” and not too high.

More recent success stories of development like Thailand, Indonesia, and Vietnam have adopted minimum wages, but their minimum wage levels have been much lower than the Philippine minimum wage in dollar equivalents.

Their other advantage over us has been their promotion of foreign capital as a partner in their development. They had fewer limitations on foreign capital unlike us. We were fine-tuning selective policies. They were not hampered by the kind of restrictions on foreign capital that has hampered us over the decades because of our Constitutional restrictions.

Wage-setting in situations where no government mandated minimum levels are interfering are based on productivity of labor. Companies normally want to pay labor in relation to their contribution to the firms’ production. So they invest in more capital equipment to make their workers even more productive. This is one reason why the entry of foreign capital in such economies have lifted labor productivity rapidly, especially in comparison with us. In fact, the pressure on the demand for labor goes higher in such countries because of the rapid rise of employment because of rising production.

These policies are also complemented by regulations that make it difficult for companies to fire or to reorganize. There is need to introduce flexibility in the labor market so that firms can adjust to changing circumstances much more easily.

Although I have written more on the subjects, two columns on the subject are more recent. (See: Crossroads, “Making labor policies modern and flexible,” PhilStar, April 14, 2021 and May 12, 2021).

Let me quote freely from these two columns of the past.

We are now a country of 109 million people, with an active labor force of around 64 million workers. On average, employment for years has hovered over a range of six to 10 percent of the labor force, but the underemployment covers around 20 percent among the employed.

One indicator of well-being, though imperfect, is GDP per head. Using dollars of equal purchasing value, the Philippine GDP per head in 2019 (well before the pandemic) was $9,302.

Compare this per head statistic with that of our neighbors in East and Southeast Asia: South Korea, $44,011; Taiwan, near-that-of-Korea; Thailand, $19,276; Malaysia, $29,619; Indonesia, $12,334; and Vietnam, $8,357.

It should be remembered that among these countries, shortly after our independence, development experts had viewed the Philippines as the country most likely to succeed in development next to Japan, which was then a country rising from the ashes of defeat from the world war.

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The informal sector is the final receptacle of job-seeking. It is where poor people and those who cannot find good jobs under the legally protected wage and employment standards obtain the means of livelihood for their sustenance.

The good jobs are available mainly in the organized, formal sector of the economy, where labor rules and regulations are applied. This is the modern sector of the economy where compliance with labor rules and regulations is followed.

In the modern formal sector, the establishments that positively respond to the government’s investment incentives undertake their economic operations. This is where established domestic enterprises find dominance. It is also where foreign direct investments locate.

For archives of previous Crossroads essays, go to: https://www.philstar.com/authors/1336383/gerardo-p-sicat. Visit this site for more information, feedback and commentary: http://econ.upd.edu.ph/gpsicat/