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Wednesday, 5 August 2009

When employment laws misfire

An interesting article from our resident contributor Murray Sanderson in the latest ZIPPA Quarter Journal on the important question of employment laws. I agree with much of the article but the treatment on minimum wage is slightly simplistic. New evidence from other developing countries does show that decentralised minimum wages can raise both employment and wages, in line with classical theory of monopsony labour markets. I know opinion on this is divided! See the exchanges on ZIPPA on Unemployment and What they pay Zambian security workers... :

Creating employment is an aim we Zambians constantly talk about. And yet, under the 'Employing workers' category in the World Bank's 'Doing Business' publication, Zambia rates as low as 135 out of 181. Can this disappointing showing be the result of worker-friendly policies?

First, a general point from economics: when a thing is costly we buy less of it. High prices encourage suppliers, but they discourage buyers. The buyers of labour are employers. Set the price of labour higher than employers are willing to pay, and they will either not buy at all, or they will buy less.

Who sets the price for labour? Isn't it the buyers and sellers themselves, the employers and employees? That is certainly true in a free market.But labour markets are often not free, or not wholly free, for political reasons. Workers outnumber bosses, so they have more votes. And politicians want votes, so they pass laws which enforce minimum wages. Such laws are popular. But there is a snag: legislation that boosts wages discourages job creation. This has happened in Zambia, but to point it out is unpopular, so no one talks about it, at least not in public. Let's look at two areas where apparently positive policies have had negative results.

The Minimum Wages & Conditions of Service Act empowers the Minister of Labour & Social Services to issue statutory instruments which set minimum wages for all non-unionized workers. That is fine for people already in employment, but it creates a serious obstacle for the unemployed, especially for those without training or work experience. Most young unemployed Zambians would be glad to accept a job at a rate well below the official minimum wage. But the employer offering it would be breaking the law, and so would the person accepting it. So school leavers are denied the opportunity to get work experience, gain skills andestablish a track record. To put it bluntly: our minimum wages law considers only those already in work, it ignores the unemployed. This is an area where we need to think again.

The other big area where labour legislation discourages employment is terminal benefits. Businesses without pension schemes are bound by law to pay 3 months pay per year of service as a gratuity to workers who retire after reaching 55 years of age and completing 10 or more years of service. For long-serving employees that can amount to a huge sum, far more than most businesses can afford to pay. The fear of incurring such situations is bound to discourage businesses from creating permanent employment. No less important, the provisions of this law are very unfair to employees, for the following reasons.
The employee who moves to another employer before reaching retirement age loses the entitlement.
It is also lost if he or she leaves for any other reason, such as to become an entrepreneur.
The same occurs if the employee dies before reaching retirement age and completing 10 years of service.
An employee who is dismissed for an offence forfeits the entitlement.
All employees can lose out if the employer goes out of business.

Another kind of terminal benefit is redundancy pay, which Zambia by statutory instrument sets at 2 months pay per year of service. This may not sound a lot, but for a company which has to reduce staff numbers because of difficulties it can be a serious problem. So it acts as an incentive to keep the workforce as small as possible.

Other countries seem to recognize this danger, for few of them insist on redundancy payments in excess of one month's pay per year of service. Indeed, among the 181 countries covered by 'Doing Business', Zambia's benefit level is equaled or exceeded by only three countries, Ghana, Sierra Leone and Zimbabwe. Alas, mandatory generosity to workers who lose their jobs can be a major obstacle to job creation.

These considerations suggest that 'worker-friendly' legislation can fail to achieve its purpose, and may seriously discourage employment creation. It is surely time for a careful review of our Minimum Wages and Conditions of Service Act. Even the best intended laws can misfire.

5 comments:

  1. I am intrigued by Cho's comment, 'New evidence from other developing countries does show decentralised minimum wages' (what are they?) 'can raise both employment and wages.' If I didn't have such a high regard for Cho's reasoning I should say 'Bunkum!', for I can't conceive of a situation where raising the price of a commodity, whether a product or a service, can increase the quantity purchased. I shall be most interested to learn of the countries where this happens.

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  2. Murray,

    Thanks for you contribution. I have a tendency to simplify at times. In that case, I was more concerned about people reading your thoughts.

    There's a lot of literature that shows conflicting view points on the impact of minimum wages. This recent paper has a short but useful literature review (section 3) : HOW DOES DECENTRALISED MINIMUM-WAGE SETTING AFFECT UNEMPLOYMENT

    It is the sort of thing I have always emphasized that "evidence" by its nature is complicated and settings are important. There are good grounds for believing that minimum wages can raise both employment and wages. Indeed that same paper observes :

    "A more interesting finding is perhaps that a minimum-wage hike is associated with a net increase in total (formal and informal) employment: the increase in informal-sector employment more than o sets the corresponding loss
    of jobs in the formal sector. This fi nding is consistent with the "lighthouse eff ect", described by Neri, Gonzaga and Camargo (2001) in the case of Brazil, which we also find for Indonesia, whereby informal-sector earnings rise in tandem with the minimum wage, thus attracting inactive workers into the labour market..."


    By "decentralised minimum wages", I was referring to minimum wages that are set differently across different areas or indeed sectors.

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  3. Murray,

    As a fellow small business owner, I feel you man! At the same time, I would really like to engage more over the differences in scale you and I are dealing with. I guess what I am getting at is that in highly general terms your business and mine are the same size, but within the US economy we are next to nothing, even in the city economy, whereas yours is likely a significant percentage of total local economic output.

    Let me put it another way, the beleaguered US Banks which have caused all this trouble are predicted as of today (as reported by CNBC) to expect a record US$38.5 BILLION in overdraft fee collections alone. My small business operates in a domestic economy where convenience collections (this is after debt from true "deadbeats" has already been written off), from the segment of the population which is merely relatively disorganized represents a annual industry 7 times the national budget, and 9.5 times the profits of the entire mining sector combined.

    Too much of the capital share of Zambian profits goes overseas, is taxed (if at all) overseas, long before it comes back as reinvestment. I have no doubt but that your taxes and mandated minimum wages are too high. The US state that I operate in has the highest minimum wage in the nation (and far from the highest cost of living standard), but we get more immigrants and domestic migrants than we can handle, and have higher average unemployment as a result.

    Given that I am in a service industry, this works out wonderfully for my business plan, which is about leveraging advantage in non-consumer priorities (like reduced overall financing % overhead (my business has never taken a bank loan, everything is done with share capital and operating profits), 10-year amortized rental costs, and location, location, location), which enable us to offer compensation well above both the national and state average for our industry. We draw the best, most confident and self-motivated staff from the downtown pressure cookers, because our environment allows them to make the same money by attracting their own customer base. They make as much because we in management can afford to demand less from each sale (and have less pressure from external forces to do so).

    I have found that there are usually ways around employer/labour laws if everyone involved is on the same page. My cursory glance at the relevant statutes, and I am by no means qualified before the Zambian Bar, indicates that were your employees to form a Union which accepted a compensation package that could reasonably be represented as greater than minimum legal employment requirements, in spite of an apparently lower rate of hourly compensation, then you should be fine. This is especially true if no-one has any reason to complain. I've helped a few businesses in various jurisdictions set up these kinds of arrangements, so if you or other Zambian business owners are interested in exploring the more positive potentials of "structural adjustment" without IMF involvement, just let me know (I don't charge for my time if I don't get put on a timetable).

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  4. Thanks, Cho, for giving us the source of your statement that legislated minimum wages can raise both employment and wages. I have read the article about Indonesia with interest, but am still not persuaded.

    Here are two quotations:

    'Our main finding is that an increase in the relative value of the minimum wage is associated with higher informality and lower formal sector employment.'

    'A more interesting finding is perhaps that a minimum wage hike is associated with a net increase in total (formal and informal) employment. The increase in informal-sector employment more than offsets the corresponding loss of jobs in the formal sector.'

    That sounds fine, but we need to ask how the increased jobs in the informal sector compare with the jobs lost in the formal sector. They are probably lower paid, and they are almost certainly without the conditions of service which go with formal sector jobs, such as medical cover, housing, paid leave and terminal benefits.

    The article talks of 'the lighthouse effect' whereby 'informal sector earnings' (but probably without non-wage benefits) 'rise in tandem with the minimum wage, thus attracting inactive workers into the labour market.' However, attraction does not create more jobs, but just a greater demand for jobs. We have plenty of that already.

    Finally, there is the statement, 'However, in a non-competitive environment the minimum wage may have a positive rather than a negative effect on employment.' Where do these non-competitive markets exist? In Cuba?

    Regrettably, I am not persuaded by the article. There seems to be more special pleading than helpful information. We need detailed evidence. How wonderful it would be if minimum wages did indeed create employment. If so,let's go on raising them.

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  5. Murray,

    "Thanks, Cho, for giving us the source of your statement that legislated minimum wages can raise both employment and wages".

    It is but one example. My source is my own intuition that when we depart from competitive labour markets it is possible to do both. The question is whether empirical evidence backs this theoretical position and the role that decentralisation has. I have shown you a paper that makes it clear that evidence is MIXED.

    "That sounds fine, but we need to ask how the increased jobs in the informal sector compare with the jobs lost in the formal sector. They are probably lower paid, and they are almost certainly without the conditions of service which go with formal sector jobs, such as medical cover, housing, paid leave and terminal benefits."

    I think that is a perfect question to ask though we must recognise it is difficult to reach definitive answers even on the basic question of "what is the economic value of a job". Classical economists will for example remind you that a job is not an economic benefit but a cost (since no one wants to work). Keynesians will remind you the multiplier effect and the importances of increasing the national piece. My point is that this is complicated question. It is true formal sector jobs may be more highly paid, but may be they only occur in urban areas and poor areas worsen etc.

    "The article talks of 'the lighthouse effect' whereby 'informal sector earnings' (but probably without non-wage benefits) 'rise in tandem with the minimum wage, thus attracting inactive workers into the labour market.' However, attraction does not create more jobs, but just a greater demand for jobs. We have plenty of that already."

    I don't follow your logic here. The lighthouse effect assumes higher wages provide a signal for people to make themselves available. This increases labour supply which is met by existing labour demand. It might help for your to expand a little more.

    "'However, in a non-competitive environment the minimum wage may have a positive rather than a negative effect on employment.' Where do these non-competitive markets exist? In Cuba?"

    First all markets are not perfectly competitive. There's always a degree of "non-competition".

    There are many areas where non-competition exists e.g. Local Mining Companies hold monopsony power. This is why mining companies are able to depress wages and even fire and hire workers at will.
    Another example is the Public Sector. In Zambia the public sector exercises a lot of monopsony power.

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