Saturday, 21 April 2012

Wage-fix proposal too much of a shock?

Can a radical idea being floated to narrow Singapore's income gap work, or does it pose too much of a risk? Insight takes a closer look at economist Lim Chong Yah's proposal
By Leslie Koh , Goh Chin Lian, The Straits Times, 20 Apr 2012

ON PAPER, it had a benign-sounding name: Economic Restructuring (ER) II, as eminent economist Lim Chong Yah has taken to calling it. But his bold idea to raise wages very quickly earned the title 'Shock Therapy'.

ERII aims to narrow the income gap - which Professor Lim says is approaching 'dangerous levels' - through several key measures. They are:
Raising the pay of all workers earning below $1,500 a month by 50 per cent over three years.
Giving smaller pay increases to those earning between $1,500 and less than $15,000.
Freezing the pay of those earning $15,000 or more for three years.
Essentially, by making it more expensive to hire even the cheapest workers, Shock Therapy aims to force employers into raising productivity quickly, so they get more output for every unit of input - which would compensate for increased wage costs.

Is this the solution Singapore has long sought? Or is it, as one economist termed it, 'economic suicide'?

Is there merit to the idea? Even if not taken in its entirety, can parts of the plan be adapted to address a yawning divide between rich and poor? Or is it the case that the debate on the proposals is enough of a shock to press home the point about the need for everyone to give productivity more of a push?

Insight unpacks Shock Therapy.

Meddling in the market

ONE criticism of Prof Lim's wage therapy is that it distorts the market.

Call it what you will - price fixing, minimum wage - the argument here is that forced wage hikes at the low end and a freeze at the top end hinders the market's ability to deploy labour efficiently.

National University of Singapore labour economist Shandre Thangavelu says: 'Developed countries like Canada and Australia try to address this widening wage gap through a larger social net, by providing more financial support like childcare benefits and unemployment insurance. They don't distort the market.'

Economist Hoon Hian Teck at the Singapore Management University (SMU) is also concerned that the market's ability to balance supply and demand in different industries will be affected.

'We are now a mature economy, and the scope for achieving the kind of equitable outcome through broad instruments such as national wage guidelines in quantitative terms might not be the most appropriate,' he says. 'It can produce big inefficiencies across individual firms.'

Surely, few would dispute that free markets do the best job of allocating resources?

That answer depends on what purpose you want the resource allocation to serve. If the goal is to maximise returns on capital, then yes, free markets work well.

However, if the goal is greater social equity or protection of vulnerable groups, then the market in and of itself is insufficient.

In 1979, the Singapore Government carried out Economic Restructuring I, to spur a transformation of the economy that market forces alone would not have brought about.

Prof Lim, as the founding chairman of the National Wages Council, was behind ERI.

In a nutshell, it involved raising wages across the board by 20 per cent a year over three years, to spur transition of the fledgling nation's economy from one that was low-skilled and labour-intensive to one driven by technology and knowledge.

Today, there is disagreement on whether ERI was a market intervention that worked or failed.

Labour chief Lim Swee Say said last week that ERI resulted in wage growth outstripping productivity gains, firms becoming uncompetitive and Singapore sliding into a recession in 1985.

That is why Singapore abandoned its high-wage policy for the current one centred on productivity and innovation, Mr Lim said.

On Wednesday, Prof Lim countered such criticisms in a press release in which he pointed out that Singapore's economy grew on average by 9.2 per cent a year in the five years following ERI.

As for 1985, it was a regional and not a national recession, he argued. Malaysia, he noted, which did not implement ERI, saw its economy shrink by 0.25 per cent a year in 1985 and 1986, compared to Singapore's 0.05 per cent growth in those two years.

Prof Lim maintains that ERI was effective in boosting not only wages, but also productivity and economic growth. However, his view has not prevailed.

Since the 1985 recession, the Government has never again intervened in the market to raise wages. However, it has intervened to do the opposite, to cut wages by cutting Central Provident Fund contribution rates. It did so in the 1998 and 2003 recessions, to save jobs.

The Government is thus not averse to steering wages in the right direction when the situation warrants it.

In that light, Bank of America Merrill Lynch economist Chua Hak Bin notes that parts of Prof Lim's latest proposal are worth looking at.

'A minimum wage is not as distortionary (for the labour market) as it might seem,' he says. 'Other countries have done it to protect less-educated workers. It's worth exploring.'

But Dr Chua regards Prof Lim's wage freeze proposal as the 'most controversial' part of ERII. Top earners, he points out, contribute the biggest share of taxes and play a key role in growing companies' - and a country's - wealth. If their incomes are capped, 'inequality will be less... but the country overall could be poorer off'.

This view - that to cap incomes at the top is to invite a flight of both talent and capital - is held by many. Prof Lim's suggestion to hold down wages at the top end is thus unlikely to gain traction.

However, his proposal on wages at the other end has shone the spotlight on the slow progress thus far in pushing up productivity and the incomes of workers at the bottom.

Stepping up the pace

THE work of cajoling employers to change the way they do things so as to raise productivity, and hand-holding them through the process, is painstaking and time-consuming.

As secretary-general of the National Trades Union Congress, Mr Lim knows that well.

But he thinks the pace will pick up in the next five years, he said last week, mainly because of the Government's determined push to slow the inflow of foreign workers.

As this process of raising incomes through productivity gains is ongoing, the Government has stepped in to top up wages at the bottom through Workfare, and to fund the training of low-wage workers, he pointed out.

In fact, Prof Lim's proposal to channel part of the 50 per cent wage hike he is championing to worker training is unnecessary, Mr Lim said.

With the Workfare Training Scheme in place, low-wage workers do not have to worry about training costs as the Government picks up the tab.

His concern, and that of other political office holders and economists who have spoken up on Prof Lim's proposed wage hike, is that companies which cannot afford such a sharp increase in labour costs will respond by cutting jobs.

Economist Davin Chor at SMU notes that many firms here, particularly those in the more labour-intensive industries and small and medium-sized enterprises (SMEs), already face low profit margins.

'How would these businesses absorb such a large increase in their wage bills in such a short span of time? If some of these wage costs were to be passed on to consumers, would Singaporeans be willing to accept sharper rises in the cost of living?' he asks. 'This wouldn't just be shock therapy for the labour market, but for the entire economy as a whole.'

Another objection is that it would be very difficult to raise the productivity of low-wage workers by the same quantum, so as to justify and sustain these higher wages.

To that, Prof Lim has this counter-argument: Low-wage workers here are grossly underpaid to start with, so raising their wages by 50 per cent will not result in wages marching ahead of productivity. Rather, wages will still lag behind national productivity gains, he argues.

'Our lowly paid workers have been underpaid by much more than 100 per cent of their pay compared with their counterparts in countries with comparable national affluence such as... Japan or Australia,' he wrote in a commentary this week.

Economist Tan Meng Wah, an associate faculty member of UniSIM, agrees that such an adjustment is long overdue.

'The unsavoury truth,' Dr Tan says, 'is that low-income wage earners are simply stuck at a very low base-wage now, and raising it incrementally by associating it with productivity improvement will hardly make a difference in mollifying the hardship many are in... even if the costs of adjustment are going to be substantial, that wrong must first be put right.'

As for feared job losses, Prof Lim says the labour market - now at full employment - will soak up workers knocked out by SMEs moving out or going bust.

In other words, now is a good time for ERII, he maintains.

Still, many questions remain as to whether Shock Therapy is the best way to realise the desired goal of closing the income gap.

SMU's Prof Hoon says: 'It's a question of what is the best instrument to achieve that narrowing of the wage gap. I find fundamental difficulty with this broad-brush approach to achieve that target. Applying a single formula to all workers fails to take into account the diversity of industries.'

Sceptics also point out that the situation now is quite different from that in 1979. Singapore industry was then predominantly made up of labour-intensive manufacturing like textiles, and it was much easier to boost productivity through mechanisation and technology, and to switch to capital-intensive, higher-value manufacturing such as electronics.

Now, after the move to knowledge-intensive sectors like pharmaceuticals, the room for productivity growth is more limited. Many workers have also gravitated towards services, where productivity gains are harder to achieve, they said.

At this point in time, it looks unlikely that Prof Lim's call to use wages to spur productivity growth will replace the tripartite approach of using productivity to drive wage growth.

But what the recent exchange has made explicit is the need to speed up wage adjustments at the bottom. It may lay the foundation for a new consensus on how much more the Government, employers and society should do in this area.

The value of the debate

FOR Dr Thangavelu, one idea that has come through in the recent exchange is the need for 'social correction' of the wage imbalance created by market forces.

'The idea of social correction itself and that the Government's role must be larger to correct for this, is something we need to think about,' he says, 'because increasingly, the market is not going to adjust for this social issue. The market is driven by commercial returns, not social returns.'

Prof Chor too says the exchange 'serves to highlight that there are influential voices in Singapore society who feel that more needs to be done and with more urgency, to try to raise the real incomes of the low-income households'.

He adds: 'I would expect these voices to gain more traction if the current productivity initiatives that the Government is pursuing are slow to deliver significant increases in the real incomes of these poor households over the next two to three years.'

The discussion has also allowed ideas to surface, such as that of UniSIM's Dr Tan, who suggests piloting wage rises in the domestic services sector first, before moving on to other industries. That is because wages there are among the lowest and changes will not affect Singapore's export competitiveness in the short term.

'More importantly, it gives time for policymakers to better monitor the negative impacts on the rest of the economy and fine-tune supply-side microeconomic and administrative policy measures to manage the transmission of those impacts,' he says.

As for the man who sparked it all, he tells Insight that he believes the public discussion that followed his speech on ERII has highlighted the issues of worsening income inequality and the problems linked to the excessive intake of low-wage foreign workers.

'The robust discussion in the mass media, including the Internet media, has shown that the Singapore public has become much more participatory and enlightened.

'The next step is for the Government, in consultation with the unions and the employers, to find a suitable solution to the twin pressing problems. The ball is now outside my court,' he says in a reply via e-mail.

Also significant is the way the debate itself has proceeded.

The radical proposal came just as the widening income gap has become a politically sensitive issue; yet the Government's response has been noticeably moderate, even muted.

It marks a stark contrast with a similar incident almost a decade ago, when NTU economists Tan Khee Giap and Chen Kang in 2003 concluded that a large proportion of jobs created in the past five years had gone to foreigners. Their findings - which were endorsed by Prof Lim - quickly drew strong rebuttals from the Government.

This time, the response was far more tempered. Mr Lim took pains to stress that he was speaking as NTUC chief - and not as a Cabinet minister - when he raised his concerns, and also said his comments were not a rebuttal.

Minister of State for Trade and Industry Teo Ser Luck called the exchanges 'healthy and good'.

The contrast suggests that Singapore's political discourse is evolving such that differing voices and radical ideas will not be summarily shot down.

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