Monday, October 13, 2008

Minimum Wages and Foreign Labour in Malaysia

The argument for minimum wage is essentially a socialist one – the notion that there must be a government mandate that employers pay a statutory minimum wage, irregardless of the productivity levels or the skills set of a particular employee, runs counter to the free market mantra that the price of labour (i.e. wages) should be determined by market forces.

Dr. Toh (The case for a minimum wage, The Edge, October 13, 2008) did try to camouflage his support for minimum wage (and for the discontinuing of foreign labour usage) with free market arguments. I would like to state my disagreement with some of his points.

The shift to greater automation in the firms’ production functions in our country has been hampered by the practice of government to allow the liberal import of unskilled or semi-skilled workers from overseas. This at once distorts market forces of supply and demand of labour in the labour market. Labour shortage is augmented by unlimited supply from overseas.

The above is a contradictory statement of sorts. The free movement of labour across borders is not a distortion of market forces. Labour shortage is. In an environment of labour shortage, wages are artificially raised without a corresponding increase in output, simply because there are insufficient labour supply. Why is labour different from say, from apples? If Malaysia is short of apples, should we simply bear with the high prices of apples? Why shouldn’t we import apples from countries with surplus stocks and then let the market decide on the price?

Labour shortage is augmented by unlimited supply from overseas.
Dr. Toh acknowledged that there is a labour shortage crisis in Malaysia. This shortage is most acute in the so-called 3D work; dirty, dangerous and demeaning. Most foreign labour are found in industries such as construction, manufacturing and agriculture, jobs which Malaysians shunned anyway in favour of better-paying and more pleasant occupations. If these labour shortages cannot be overcome by supply from within or without Malaysia, then what does Dr. Toh suggest we do? Let constructions sites grind to a halt?

Many countries have adopted a minimum wage policy, yet their competitiveness remains high.

Competitiveness will surely be eroded when a minimum wage is introduced, at least initially. The consulting firm Booz & Co conducted a survey of 66 multinationals with operations in Shanghai and found that 54% suggested that China has become less competitive due to rising labour costs. The reason is straightforward – labour costs are a significant portion of a manufacturer’s total costs. When labour costs go up, profit margins fall. Pricing power is weakened, and competitiveness eroded. Note that the manufacturing sector is still the largest contributor to Malaysia’s GDP in 2007. The introduction of a minimum wage will definitely adversely affect manufacturers’ competitiveness from a cost perspective.

The question is how existing players and new entrants will react to a new minimum wage. If manufacturers have the resources and initiative to modernize their plants, hence preserving their profit margins by using less workers, then competitiveness is maintained or may even improved. If new entrants are encouraged to move up the commercial food chain by venturing into higher value products or services where the inputs are biased towards capital and knowledge as opposed to labour, Malaysia’s economy will be boosted.

However, these are very big if’s. Those huge multinational companies with operations in Malaysia are most probably already employing the latest technologies there are available. It would not be inaccurate to say that these MNC’s set up shop here in Malaysia precisely because of its better skilled workers but relatively lower wages vs. the more developed countries. This is our competitive edge. A minimum wage which erodes this advantage could spur these companies to uproot and relocate to a cheaper country with cheaper labour costs, and they will be welcomed with open arms by these less-developed countries. Also, only well-capitalized firms will be able to upgrade their processes. Weaker ones will be run out of business as their costs spiral and they are unable to compete. As for many local manufacturing companies which are by nature labour-intensive, they have limited ability to create or purchase new automated techniques that mitigate their increased labour costs. Automation can only go so far, and the savings made by using a little less labour may not necessarily render net savings. The result is that both international and local manufacturers, both large and small, may relocate, reduce labour, or simply close down; too quickly for new entrants to come into the market to take its place. As one economist commented on the closure of thousands of factories in China due to rising labour costs – “it is easy to push people out, but harder to create new industries”. At the end of day, Malaysians are priced out of work, without any net gain to the economy.

Dr. Toh, in his closing statements, said “one good reason to legislate a minimum wage is the moral consideration of ensuring that our workers live dignified as human beings. The minimum amount must be sufficient to buy the means of sustenance.”

This proposition is fair. Workers are stakeholders of a company, and it is in the company’s interest to look after the welfare of its employees. However, Dr. Toh is over-emphasizing the influence of the private enterprise. It is dangerous to suggest that the private firm is responsible overall for the social welfare of its employees, and thereby must be mandated to compensate its staff a sum that is required for a minimum standard of living. Ultimately, the role of a private enterprise in ensuring a minimum standard of living for its employees is limited, since it has no influence over a myriad of factors that may cause the costs of living to go up. This is within the domain of the government. What happens if runaway inflation causes costs of living to go perpetually up? Does the private firm need to raise its minimum wage again and again to compensate for the shortfall? Where does it end? Until the firm goes bust and the employees have zero income?

Dr. Toh also mentioned that “many workers are not paid subsistence or living wage....these workers will not be motivated to work hard and not likely to have high productivity”.

Then the right market solution must to pay based on productivity, not mandate a minimum pay level that may not correspond to skill levels. The government, instead of mandating a blanket minimum wage across industries, should embark on a study of the profitability of each industry, and then link pay with productivity that is commensurate with the individual firms’ surplus. Paying a higher (minimum) wage to workers who should received less because of their persistent low productivity creates a disincentive to upgrade themselves, while it may penalize productive ones because the firm has to subsidize inefficient workers while economic output remains the same. A uniform minimum wage across different industries is likely to be damaging to those that are barely surviving and the end result is both good and weak workers are thrown out of work.

Minimum wages is a market distortion. Obstructing movement of labour is also a market distortion. Market distortions are rarely good for the economy. While there is a weak economic case for minimum wages, there could be a social argument for it. Dr. Toh must make the distinction clear, and understand that the role of the private enterprise in serving a social purpose is at best limited and at worst, even damaging to the worker that Dr. Toh intends to “protect”, when the private enterprise is unable to compete in its natural form in the face of various market distortions that Dr. Toh is advocating for.

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