RAM Economics Research

Barry OoiEconomist

barry@ram.com.my

Jason FongEconomist

jason@ram.com.my

Briefing to RAM Rating analysts

Economists’ perspectives on Malaysia’s minimum wage

mechanism

15th May, 2012

Economics ResearchOutline

2

Overview

• The current labour market• Rationale for the minimum wage mechanism• What we know so far

Perspectives

• Do we need it?• Labour markets• Inflation• Industry specific concerns

Summary

Economics Research

3

Overview

• The current labour market• Rationale for the minimum wage mechanism• What we know so far

Perspectives

• Do we need it?• Labour markets• Inflation• Industry specific concerns

Summary

Economics ResearchThe current labour market

I. Overview

4

February 2012 labour market indicators

Labour force 12.7 million

Employed 12.3 million

Unemployment rate 3.2%

Outside of labour force 7.0 million

Underemployment (2010) 0.5 million

2000 2005 20100

10

20

30

40

50

60

70

80

90

100

5.6 4.6 3.6

25.220.9

16.7

54.755.4

55.5

14.4 19.0 24.1

No education attainment Primary Secondary Tertiary

Prop

ortio

n of

tota

l em

ploy

ed (%

)

Low unemployment rate, an appropriate time to structurally adjust labour markets

Large proportion of working age population (15-64) not actively looking for jobs

Proportion of educated workforce has increased since 2000

… but sizable proportion still educated below tertiary levels

Economics ResearchThe current labour market

I. Overview

5

Agriculture & mining Manufacturing Construction Services0

10

20

30

40

50

60

70

16.323.8

8.7

51.2

12.617.0

9.6

60.8

2001 2011

Perc

ent o

f tot

al e

mpl

oym

ent

Reduction of labour-intensive industries (e.g. textiles) due to the rise of China

A large proportion of employed population in wholesale & retail sector (16%).

Number of employed (million)

Average annual growth rate, % (2002-10)

Legislators, Senior Officers & Managers 0.8 2.1

Professionals 0.7 4.7

Technicians & Associate Professionals 1.6 4.0

Clerical Workers 1.1 2.4

Service, Shop & Market Sales Workers 1.9 3.9

Skilled Agricultural & Fishery Workers 1.3 -0.7

Craft & Related Trade Workers 1.2 -0.1

Plant & Machine Operators & Assemblers 1.3 -1.2

Elementary Occupations 1.2 2.0

Lower demand for specific lower skilled segments

Faster growth for certain higher skill segments

Growth in lower skilled workers

Economics ResearchThe current labour market

I. Overview

6

Employers’ wage bargaining position

• Domestic inflation (and wages) do not fully reflect global price movements• Inadequate wage transparency• Weak union powers and representation• Young demographic profile, with significant proportion not in labour force• Immigration laws that benefit labour-intensive production

Employees’ wage bargaining position• Domestic hiring and firing procedures can be long and costly• Lower migration costs• Low unemployment rate

Economics ResearchRationale for the minimum wage mechanism

I. Overview

7

Wage bargaining process is perceived as being lopsided to the employer

• Asymmetric information (i.e. employers know more of the labour market than employees) allows employers to capture surplus

Anecdotal evidence suggest that the pace of urban inflation has increased the number of exploited workers

• Elastic labour supply conditions (i.e. near unlimited supply) in urban centres for low skilled jobs has depressed wages and caused their standard of living to diminish

• Cost of living pressures have not been adequately translated into wage growth; increasing demands for a ‘living wage’ level

Improving social welfare

• Encourages individuals to gain lawful employment, particularly for those outside the labour force

Facilitate or accelerating structural upgrading

• Increasing the relative cost of labour inputs will encourage firms to adopt more efficient production strategies such as labour-saving techniques or increasing capital-intensity

Economics ResearchWhat we know so far

I. Overview

8

Minimum wage rates

• Peninsular Malaysia – RM900• Sabah and Sarawak – RM800 (to be equalized over time)

Implementation in 6 months; 12 months for micro enterprises• Allows sufficient time for pricing adjustments (firms) and to coordinate inflationary expectations

(firms/workers)

The value includes cash, cash incentives and various allowances

• For the plantation industry, the RM200 gratuitous payment can be converted to be part of the minimum wage

Applies to foreign workers• But excludes trainees, apprentices and domestic servants

Economics Research

9

Overview

• The current labour market• Rationale for the minimum wage mechanism• What we know so far

Perspectives

• Do we need it?• Labour markets• Inflation• Industry specific concerns

Summary

Economics ResearchDo we need it?

II. Perspectives

10

Objectives of minimum wage Alternative solution(s)Balancing the wage bargaining process •Make wage data publicly available

•Empowering workers unions

Reduction of urban poverty •Unemployment benefits•Targeted subsidization efforts

Improving social welfare •Optimizing current labour laws to prevent worker exploitation (i.e. work hours/conditions)

Facilitating structural change •Incentivize firms that increase capital intensity in their production•Eliminate conditions which allow for unlimited supply of labour

Theoretically,

• A ‘market-based mechanism’ will be just as efficient in distributing a firms returns• Other laws which indirectly affect the labour market can be put into place to optimize social returns

There are rich countries without a minimum wage mechanism• Singapore, Germany, Brunei, Austria, Denmark, Finland, Iceland, Qatar, Bahrain, Sweden,

Switzerland, UAE and Italy ~ most European economies have a Gini coefficient below 0.30• Therefore, not a prerequisite for a high income nation, growth or income inequality

Economics ResearchDo we need it?

II. Perspectives

11

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

-15.0

-10.0

-5.0

0.0

5.0

10.0

15.0

20.0

Average value added per worker Average real wage

Annu

al ch

ange

(%)

In the manufacturing sector,

• Long-run productivity growth tracks well with average real wage (i.e. inflation-adjusted) growth• Is indicative of market-based mechanisms in this particular sector. • Although, growth trend of wages tend to be very ‘sticky’

CAGR (1995-2011)Value added per worker…… 3.7%Average real wage…………….3.0%

Economics Research

12

Do We Need It?II. Perspectives

Alternative solution Rebuttals•Make wage data publicly available•Empowering workers unions

• Homogeneity among unskilled workers• Unskilled workers have little bargaining power to begin with

•Unemployment benefits•Targeted subsidization efforts

• Encourages unemployment• Prone to manipulation

•Optimizing current labour laws to prevent worker exploitation (i.e. work hours/conditions)

• Still prone to collusion between employer and employees

•Incentivize firms that increase capital intensity in their production•Eliminate conditions which allow for unlimited supply of labour

• Evidence that minimum wage may raise labor productivity

Economics ResearchLabour markets

II. Perspectives

13

Demand for labour

Supply of labour

Wages

Quantity of labour

We

Qe

W min wage?

Q min wage?

Unemployed

Decrease in employment

Quantity of labour

Wages

Demand for labour

S0

S cheap labourW min wage?

Unemployed

Decrease in employment

QeQ min wage?

Outcome on labour markets is uncertain,• Differs by sector – labour needs and cost of physical capital varies by sector• Current wages may not be at equilibrium, and the minimum wage may have brought it to

equilibrium

Economics ResearchLabour markets

II. Perspectives

14

• Recent economic literature has shown minimal to no adverse effects on employment (eg. Card & Krueger (1994), Metcalf (2008), Lemos (2008))

• Possible reasons:• minimum wage too low

• incomplete coverage• impact on hours instead of employment• time horizons• “stepping stone” jobs• non-compliance• offsets• uncompetitive labor markets• pass on costs through prices• lower profits• increased productivity

Economics ResearchLabour markets

II. Perspectives

15

Jul-10

Sep-10

Nov-10

Jan-11

Mar-11

May-11

Jul-11

Sep-11

Nov-11

Jan-12

Mar-12

0.0

1.0

2.0

3.0

4.0

5.0

6.0

-0.4%-0.3%-0.2%-0.1%0.0%0.1%0.2%0.3%0.4%0.5%0.6%

Taiwan

Unemployment (LHS) Employment (RHS)

%

m-o

-m ch

ange

Jan-09

Mar-09

May-09

Jul-09Sep

-09

Nov-09Jan

-10

Mar-10

May-10

Jul-10Sep

-10

Nov-10Jan

-11

Mar-11

May-11

Jul-11Sep

-11

Nov-11Jan

-120.0

0.5

1.0

1.5

2.0

2.5

3.0

-6.0%-5.0%-4.0%-3.0%-2.0%-1.0%0.0%1.0%2.0%3.0%4.0%

Thailand

Unemployment (LHS) Employment (RHS)

%

m-o

-m ch

ange

36678 -1033yy

yy

37043 -1033yy

yy

37408 -1033yy

yy

37773 -1033yy

yy

38139 -1033yy

yy

38504 -1033yy

yy

38869 -1033yy

yy

39234 -1033yy

yy

39600 -1033yy

yy

39965 -1033yy

yy

40513 -1033yy

yy

40878 -1033yy

yy0.01.02.03.04.05.06.07.0

Vietnam

Unemployment rate

%

• Regional examples of minimum wage show little to no correlation between wage increases and employment.

Economics Research

16

0 20,000 40,000 60,000 80,000 100,0000

1000

2000

3000

4000

5000

6000

7000

8000

9000

10000

No. of workers

Aver

age

wag

e, R

M

Median of average wages

(RM2255)

Minimum wage

(RM900)

II. Perspectives

Labour markets

Retail sectorEmployment

(no. of people)Average wage

(RM)Total Retail 923,798 4,577.39

Non-Specialised Stores 278,765 3,427.20

Food, Beverages & Tobacco 76,313 2,766.81

Automotive Fuel 33,445 3,854.57

Information & Communication Equipment 96,848 6,456.31

Household Equipment 144,677 5,848.40

Cultural & Recreation Goods 64,910 5,463.92

Others in Specialised Store 213,156 5,057.47

Stalls & Markets 10,965 649.70

Not in Stores, Stalls & Markets 4,720 4,642.85

• Average wages for most workers in Malaysia are above minimum wage.

• Employers may shed foreign labour instead of domestic labour.

• Malaysia’s push towards high-income nation requires shift away from cheap labour.

• Unemployment rate in Malaysia still below natural rate.

Economics ResearchInflation

II. Perspectives

17

Minimum wage is implemented

Firms pass on costs directly to consumers

Additional domestic consumption

Revision of firm-wide pay scales (?)

Increase in pay of lower-skilled workers

‘Cost push’

‘Demand pull’

Inflation

Minimum wage mechanism and inflation

Economics ResearchInflation

II. Perspectives

18

Concerns

% of total consumption National weight RAM survey, males (2011) RAM survey, females (2011)

Food away from home 10.04 11.8 9.8

• Inflation is affected by both cost and demand channels, increasing the risk of a wage-price spiral

• Higher labour input costs can be detrimental for firms which face significant global competition or at depressed margins.

• A significant proportion of the nation’s CPI weights are in ‘food away from home’ (analogous for industries which are heavily reliant on labour). Impact of a minimum wage would likely affect urban consumers through this channel.

Economics ResearchInflation

II. Perspectives

19

Cost Push Demand Pull

• Some impact on SMEs, but Budget 2012 chock full of benefits for SMEs.

• At such low levels of income, any increases in consumption will go to food.

• Bigger, export-oriented industries have market-determined prices.

• Periodic adjustments to minimum wage aligned with inflation will keep real wages steady

• Labour below minimum wage constitute small part of production cost.

• Real wages should rise relative to imported inflation

• Ultimately depends on how firms adjust costs • Inflation currently low at 2.1%

Jul-10Sep

-10

Nov-10Jan

-11

Mar-11

May-11

Jul-11Sep

-11

Nov-11Jan

-12

Mar-12

0.00.20.40.60.81.01.21.41.61.8

Taiwan

Inflation

yoy

seas

onal

ly a

djus

ted

(%)

Jan-09

Apr-09Jul-0

9Oct-

09Jan

-10

Apr-10Jul-1

0Oct-

10Jan

-11

Apr-11Jul-1

1Oct-

11Jan

-12-5.0-4.0-3.0-2.0-1.00.01.02.03.04.05.0

Thailand

Inflation

%

Nov-09Feb

-10

May-10

Aug-10

Nov-10Feb

-11

May-11

Aug-11

Nov-11Feb

-120.0

5.0

10.0

15.0

20.0

25.0

Vietnam

Inflation

%

Economics ResearchIndustry-specific concerns

II. Perspectives

20

Labour costs (ratio to total cost) Returns to labour (ratio to total value added)Other Mining and Quarrying 68% Rubber Gloves 65%Paddy 60% Vegetables 60%Vegetables 44% Meat and Meat Production 58%Food Crops 43% Fruits 56%Oil Palm 43% Paddy 53%

Fruits 41% TV, Radio Receivers & Transmitters & Associated Goods 52%

Rubber 38% Builders' Carpentry and Joinery 52%Other Agriculture 30% Wooden and Cane Containers 52%

Rubber Products 28% Measuring, Checking and Industrial Process Equipment 50%

Forestry and Logging 25% Food Crops 49%

Economics Research

21

Overview

• The current labour market• Rationale for the minimum wage mechanism• What we know so far

Perspectives

• Do we need it?• Labour markets• Inflation• Industry specific concerns

Summary

Economics ResearchConclusion

III. Summary

22

Minimum Wage

Benefits• Redresses power

imbalance between employer and employee

• Reduces urban poverty• Improves welfare• Helps lift productivity

Costs• Unemployment: little

recent empirical evidence• Inflation: depends on how

firms adjust costs, but expected to be minimal

• Ample space for movements on either factor

Unable to gauge appropriateness of RM800-900 level at presentOverall impact expected to be minimal

RAM Economics ResearchLevel 19, The Gardens South Tower

Mid Valley City, Lingkaran Syed Putra59200 Kuala Lumpur

Tel: (603) 7628 1101 / Fax: (603) 7620 8255www.ram.com.my

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