Minimum wages: good or bad for South Africa?

The topic of minimum wages in the South African economy is a highly emotive one – given the high levels of income inequality that are present across the economy.

Recently, a panel has been setup by Deputy President Cyril Ramaphosa with the purpose of investigating the impact of a minimum wage being imposed across the economy. Labour is asking for a minimum wage to be set between R4 000 and R5 200 per month, while business, on the opposite end of the negotiating table, is asking for a lower figure.

A recent study by Arden Finn of Wits University states that 48% of all incomes are below R4 000 per month. This means that if a minimum wage was imposed at R4 000, 48% of the employed in South Africa would need to have their salaries adjusted to the minimum level. This undoubtedly would come at a significant cost in rand terms for employers, but would the positive effects outweigh any negative effects?

Figure 1 indicates the labour demand graph for minimum wage workers in South Africa at three different minimum wage levels, namely R3 000, R4 000 and R5 000 per month (assuming all other factors remain constant).

Figure 1:

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The thick, downward sloping line represents the demand for labour in the economy at various minimum wage levels which are represented by the horizontal lines A, B and C. The point at which each line (A, B and C) intersects with the demand curve represents the number of employees demanded at each minimum wage level. Figure 1 illustrates how as the minimum wage rises, the demand for employees declines.

South Africa’s official unemployment rate currently stands at 26.6% (Q2 2016). This is alarmingly high given that the majority of these workers are at the lower occupational levels (skilled and semi-skilled workers). South Africa already has an oversupply of labour in the lower occupational levels, which means that a minimum wage that is set too high would result in an increase in supply  – it would simply attract more discouraged workers (people of working age that have stopped looking for work) but would not lead to increased volumes of employment.

Arguments have been made that within the wholesale, retail and agricultural sectors, minimum wages have been imposed without significant loses of employment. In economic theory, the unit labour cost (or cost of production) increases if real wages increase without a corresponding increase in labour productivity. This means that the adjustment of salaries from their previous level to the new minimum wage level would effectively raise the cost of production as legislation (not productivity) has driven these increases. As a result of this increase in the cost of production, employers would want to employ more experienced or productive employees as they will cost the same as an entry level employee if both are at the minimum wage level.

Currently, South Africa’s unemployment rate for individuals 15 to 24 years old is 53.7%, while for individuals 25 to 34 years old stands at 31.4%. Considering these two age groups make up 46% of the labour force, these statistics are quite alarming. These two groups are typically the least experienced groups in the labour force and a minimum wage could make it increasingly difficult for these individuals to find work as employers seek out more experienced employees.

The effect on gross domestic product (GDP) also needs to be taken into account as ultimately the economy needs to grow to create jobs. Rising costs of production make South Africa’s exports less attractive and they are a significant source of economic growth opportunities for any economy. The table below indicates the annual GDP growth rate of South Africa between 2011 and 2015 as well as the latest GDP growth figure reported in first quarter of 2016.

In 2010, Pravin Gordhan stated that the South African economy would need to grow by 7% per annum for years to come to create jobs and reduce poverty. The table indicates that economic performance in recent years has fallen well short of this goal. Raising wages to a prescribed minimum level (if it is excessive) during times when economic performance is low will surely impact employment negatively, particularly within those groups (ages 15 to 35) which are less experienced. If a prudent model for achieving wide spread minimum wages is not followed and the resulting minimum wage is excessive, an inefficient cycle could develop as depicted in Figure 2.

Figure 2:

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Figure 2 is a scenario which could develop if the minimum wage imposed is excessively high considering South Africa’s current economic growth environment. Although the idea of higher minimum wages is attractive to the common citizen, care must be taken to not fall into the trap of making populist policy decisions to simply appease the people in the short term. Achieving long term shared economic growth is the ultimate goal as it will lead to job creation and result in higher levels of pay to uplift the standard of living of the average South African. It cannot be achieved by simply introducing pay increases because legislation says so.

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