The Economics of Wages

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Thursday, November 15,  2018 / 11:15 AM / FDC                             

 

The concept of a minimum wage is universal and has its origins in the Poor laws of the 18th century Britain, the early days of the industrial revolution. Workers were of the view that capitalists were exploitative. They believed that minimum wage helps mitigate the imbalance of power between employers and low-wage workers. In the absence of a wage floor, employers could take advantage of workers’ vulnerability and weaknesses. This could undermine the purchasing power of low income earners.  

Therefore, it is not surprising that the minimum wage debate in Nigeria has generated a lot of passion. In pure macroeconomics terms, a higher minimum wage could trigger structural unemployment as more workers are being attracted to work while employers could be less willing to take on additional labor. More importantly is that GDP which is a measure of aggregate output is dependent on factor inputs (labor and capital). 

As labour demand declines, there is a downward movement along the production function leading to a lower real GDP. In addition, a decline in the quantity of labor, given the current level of technological advancement could result in low labour productivity, resulting in an inward shift in the production function and hence lower GDP. Hence, lower output coupled with a boost in liquidity would mount inflationary pressures. 

In Nigeria, the minimum wage has been a subject of acrimonious debate for years with policy makers and labor in a virtual deadlock. The Nigerian Labour Congress (NLC) and the Federal government recently reached a tentative agreement on a figure of N30,000, averting another slowdown. N30,000 is 67% higher than the current wage of N18,000. The minimum wage was last reviewed in 2011, when a 140% increase was implemented from N7,500. At that time, N18,000 was worth $200 in the forex market. According to the law, the minimum wage should be reviewed at least once every 5 years. This implies that this review is almost two years overdue. 

One of the major justifications for the wage review remains the deteriorating macroeconomic conditions i.e. lower purchasing power. This has resulted in a higher cost of living and a decline in the standard of living. The proposed minimum wage – at about $83 per month – is still suboptimal compared to what was paid in 2011, when the dollar equivalent of the minimum wage was $200. To restore a low wage earner back to the level it was in 2011, the optimal minimum wage would be approximately N72,000. To compensate for the value lost to inflation, the optimal wage should rise even further to N130,000. Nonetheless, the implementation of the new wage is expected to have both positive and negative impact on households as well as the aggregate economy.  

 

Positive Impact

A higher minimum wage would boost employees’ purchasing power, increase aggregate demand and ultimately stimulate economic growth. Consumption accounts for a significant proportion of the Nigerian National income model. Hence, a boost in consumption would significantly impact on the country’s national income. In addition, an increase in consumption would induce investment spending, which would then have a multiplier effect on the overall economy.

 

Negative Impact

An increase in the minimum wage will boost liquidity and increase aggregate demand. However, given the structural rigidities as well as poor labour productivity in Nigeria, it is unlikely that output would increase to meet rising demand. This would result in a shift in equilibrium and the spike in money supply will likely be a destabilising factor for price stability. Furthermore, firms could reduce labour demand in response to higher labour costs and take drastic measures such as downsizing. This would increase the unemployment numbers. 

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In addition, given the current economic conditions in Nigeria, the fiscal sustainability of this new minimum wage regime is questionable due to limited progress made on increasing non-oil revenue, huge budget deficits and rising federal and states’ debt. An increase in recurrent expenditure stemming from the wage increase could crowdout the much needed capital expenditure. Some states are in a struggle to meet their current wage obligations. Thus, a higher minimum wage would compound this dilemma.

 

Conclusion

While it is expedient to implement the new minimum wage, it is more important to broaden the country’s revenue base. There is a need to deepen non-oil revenue collection and increase the efficiency of tax collection.  

There is also a need to boost aggregate output which is constrained by the inadequacy of existing infrastructure – especially power supply. An improvement in power supply will lead to a reduction in demand for alternative sources of energy such as diesel. This would reduce firm’s operating costs, increase profit margins and improve the private sector’s ability to pay the proposed minimum wage. In addition, higher profits imply more revenue to the government in form of higher tax receipts. 

 

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