Limits in linking productivity to wage increases

By Tan Meng Wah, Published The Straits Times, 9 Jun 2012

THE recent headlines and debate over Professor Lim Chong Yah's 'wage shock' therapy were in fact a diversion from a deep-seated and long-standing problem: how to raise the incomes of low-wage workers.

Concerned that the 'shock therapy' of a mandated across-the-board wage increase may derail economic development, the Government fell back on the hard-to-refute economic maxim that links wage rises to productivity growth.

That sounds perfectly reasonable, but this strategy has its own failings.

Other factors at play

FIRST, the 'no productivity growth, no wage adjustment' approach assumes that low productivity is the key, if not the sole cause of low income growth for less-skilled workers.

In reality, other factors may also be at play.

For example, business costs may have gone up rapidly in recent years. Rental for retail outlets, for instance, has shot up because of the growth of REIT (real estate investment trust) activities. This dampens employers' ability to raise the salaries of the large number of low-wage workers in the retail sector.

Secondly, increasing workforce productivity both at the sectoral and the national levels is easier said than done.

Multinational corporations in high value-add manufacturing operations can recoup aggressive capital investments to raise productivity because of their high profit margins and economies of scale.

Local manufacturing small and medium-sized enterprises (SMEs), on the other hand, will find it hard to defray their capital investment from a lack of scale.

SMEs in the low value-add labour-intensive service sector face even more severe limits in boosting productivity through capital investment.

How can a bus driver who is already driving a double-decker bus increase his total value-add? He can't drive two buses at once.

Elusive quest

THE elusive nature of productivity growth is hardly peculiar to Singapore. Other developed countries face the same problem. A developing economy like China has tremendous room for productivity growth because of market inefficiencies attributable to anti-competitive and rent-seeking actions and policies.

For an ultra-efficient economy like Singapore's, any such room for productivity growth has longbeen exploited. Research by McKinsey in 2004, for example, revealed that over a period of 30 years, Japan's economic growth was generated more by increases in the number of hours worked and the amount of capital equipment used than by an increase in the workforce's productivity.

A small, mature economy like Singapore faces constraints in boosting productivity. Simply put, there are limits to its factors of production.

Even if capital is plentiful, but labour and land are scarce, there is a limit to how much growth can be achieved even with more productive use of labour and land.

Further capital investments may even result in diminished marginal returns.

If that happens, what recourse is there for workers but to work longer hours to boost income? And for more members to join the workforce to boost household income?

This might explain policymakers' increasing use of household rather than individuals to track income data.

Undervalued workers

ANOTHER limit in linking productivity to wage increases is that the concept of productivity tends to undervalue the efforts of low-wage workers while overvaluing those of the top executives.

In a tightly integrated value chain, the sum is usually more than its parts.

Productivity takes into account the value created directly by each worker but not the surplus value created by the company as a whole.

That surplus value, which shows up as profit, ends up frequently as big pay packets and bonuses to top management as well as fat fees to the board of directors who have a say in the pay of top management.

In the United States, for example, even though output per hour rose by 70 per cent between 1981 and 2006, average real hourly wages were virtually flat, increasing from US$7.88 in 1981 to US$8.23 in 2006.

In contrast, the share of corporate profits in national income in 2006 was close to the highest levels since 1947, and the share of wage income of the top 1 per cent of wage earners was almost double the level recorded in 1980.

Based on data from the US Census Bureau, about 5 per cent of annual income shifted from the middle class to the richest households between 1980 and 2010. In 2010 alone, the wealthiest 5,934 households reaped an additional US$650 billion (S$816 billion) more than what they would have got had the economic pie been apportioned based on the ratio in 1980.

Blame game

FINALLY, blaming the income gap on productivity may conceal underlying and fundamental issues that need to be relooked.

The unfettered pursuit of market fundamentalism, for example, may allow power to be skewed towards increasingly well-organised capital owners.

The entire capitalist system is more attuned to rewarding capital owners who use money to make more money, while shunning workers who have to sweat and toil to barely earn a decent living. It is timely in Singapore for policymakers to re-evaluate priorities so that workers can reclaim the dignity and full value of their labour.

In the end, productivity growth is hardly the panacea to the problem of rising inequality in income distribution: because other factors dampen wage growth; because productivity gains are hard to come by and may be severely limited in a small, mature economy like Singapore; and because gains from productivity, if any, may accrue more to management than to workers.

But even if productivity growth is achieved, it is likely that income growth for PMETs (professionals, managers, executives and technicians) will outstrip that of unskilled workers, broadening the wage gap.

Wage policies underpinned by productivity growth may allow incremental pay increases to keep up with inflation, but can do little to narrow the sizeable income gap that already exists. Such fundamental adjustments can realistically only take place by giving employees a larger share of the economic pie.

However, this entails encroaching on the deep-rooted vested interests of other stakeholders, and can only be effected by leaders with strong political will.

In short, simplifying the issue by falling back on an economic maxim about productivity and wages makes good economic sense, but may lose out in overall effectiveness.

The writer, who recently finished his PhD in world economics at Nanjing University, is an associate faculty member of UniSIM.