Friday, May 26, 2006

Labor Econ 1: What Determines Wage?

The determinants of labor supply and demand:

1. Labor supply: mainly determined by population growth and migration; also, the skills and education level of education of the workforce.

2. Labor demand: mainly determined by the size and growth of the economy. More economic growth, more business activities, more jobs created.

3. Equilibrium wage: the level of wage where supply meets demand in a given skills level. Thus, you can have numerous and endless equilibrium wages for numerous type of labor supplied and demanded: for domestic helpers (rich, middle class, poor households), construction workers, agricultural workers, aquaculture workers, hotel and restaurant workers, transpo workers (airlines, shipping lines, bus lines, taxi lines, vans, etc.), scientists, engineers, chemists, lawyers, economists, etc.

What determines wage increase?

3 main schools of thought:

1. Wage is a function of cost of living of a family: A family of six would need Pesos xxx per month; hence, this should be the minimum wage. The minimum wage is the level that even the most unskilled worker must receive.

2. Wage is a function of increase in price of commodities (inflation rate): The consumer price index (CPI) has moved up from xx to yy points over the last nn years; hence, wages must increase by a proportionate rate, if not higher.

3. Wage is a function of productivity: Whether the worker is single or has 10 children, or inflation rate has increased by 1% or 20% per year on average, if productivity has not increased, wages cannot increase. Otherwise, the company will close shop and workers will be jobless.

The philosophy of government setting minimum wage and the succeeding legislation and tripartite contracts are supposed to protect workers from underpayment and exploitation by their employers. The goal of worker protection is good and laudable, except that the means, minimum wage-setting by government, depresses the dynamism of the labor market.

Setting a government-mandated minimum wage way above the expected productivity of unskilled people, if strictly and rigidly implemented, will result in those unskilled people being hired by no one except the charity-oriented organizations and individuals. If the number of the unskilled people are much plentier than what charity people and organizations can absorb and employ, then the rest of those unskilled people will go hungry. In short, minimum wage and related laws protect only those who already have jobs, but discriminate the unskilled who are not employed yet.

That minimum wage should be xxx $ (or Pesos or other currencies) per hour, per day, per month, because that is what a family of five members (couple + 3 children) will need to live decently, regardless of the skills of the worker, will again work against the unskilled. There will be temptation and incentives for employers to hire only unmarried people, or married but have no kids yet (or have only 1 or 2 kids) so that the “needs of family of five” argument will not apply to the workers in negotiating for wage adjustments. And those unskilled workers who have plenty of children will be condemned to perennial joblessness, perpetuating further that family’s poverty.

Indexing wages to inflation rate is also inadvisable. Inflation rate can climb fast for a hundred reasons, like high interest rates due to government over-borrowing to finance the budget deficit; damage to crops due to strong typhoons, hurricanes, floods, or volcanic eruption; supply disruption due to damage to roads and bridges from the food- and other commodities-producing provinces because of earthquake, sabotage, fire; hike in transportation cost due to world oil price increases, and so on.

If wages will be forced by government or by strong labor federations to be adjusted upwards because any or all of the above happened, and there is no corresponding increase in overall firm productivity, or increase in the firm’s revenues, then that company will be forced to either lay off some workers, or just close shop, even temporarily.

Wage is a function of, is determined by, a worker’s skills and productivity. It is not a function of the number of children that a worker has, nor is it a function of the change in consumer prices (or inflation rate). Because if this were so, then workers can have 4, 8, a dozen children, and pressure the state to pressure the businessmen and employers to increase their pay because their needs to live decently, from food to clothing to medicines, have increased. In a situation of many poor economies like the Philippines where labor supply always exceeds labor demand every year because of fast population growth, the army of the unemployed will keep increasing and poverty incidence will keep expanding.

Many people, especially ordinary employees, aspire to become start-up entrepreneurs someday. In fact, people should not aspire to become “ordinary employee forever”. Unless their company or organization keeps expanding so that they are assured of continued career mobility until they retire, workers should dream of becoming “their own boss” someday. This will put them on the same situation as their former employers, and this will temper them from making unreasonable demands that are beyond the capacity of employers to be granted. Conversely, if employers know that their current hard-working employees will leave them soon to put up their own start-up enterprises, they will be forced to give good pay and benefits to encourage said self-driven employees to stay in their companies.


Niq said...

Hi Sir! We have a research paper on labor market in the Philippines. I just want to ask you if how can we determine the equilibrium wage in the Philippines for a given period of time. Is there any statistic or a study on this? Thank you sir

Bienvenido Oplas Jr said...

Hi Niq. You, DOLE, NEDA, OP, UN, ILO, WB, ADB, etc. -- can NOT determine the equilibrium wage in any sector or sub-sector, much more for the entire country. Who can? Only the employers and employees in each single firm.

Even in the same company, say Victory Bus Line, not all drivers have the same pay. The more experienced, or those who have zero accident experience, have higher salaries than their fellow drivers in the same bus line.

Check my newer paper, Econ for Statists 8: Minimum wage law is wrong, July 07, 2011,