Tuesday, August 24, 2010

Real wages

As countries continue to reel from the financial crisis, the Asia-Europe Peoples’ Forum (AEPF) has a proposed solution: Raise real wages. Their words.
Charles Santiago, Member of Parliament of Malaysia and AEPF co-coordinator in Asia, proposes a solution to the crisis that has a much longer effect: Raise workers’ real wages.
“Government is subsidizing business when it bails out banks using the stimulus packages. The money should go directly to the people. This is a more sustainable option.”
How sustainable is it? First of all, the AEPF is proposing an increase in workers' nominal wages: mandating perhaps an increase in the minimum wage of workers across the board. This is fine, but does that translate to an increase in real wages? Often, it does the opposite.

How are real wages increased? Real wages are increased when workers' wages can buy more stuff. For example, a worker's 100 pesos used to buy 2 kilos of rice, then later his 100 pesos can buy 3 kilos of rice of the same quality. His real wages have effectively increased even if his nominal wages remained the same since the money he has can buy more stuff. When does this happen? It happens when more products are produced such that the demand for these products do not exceed the supply disproportionately. Does increasing workers' nominal wages lead to an overall increase in the production of goods and services? That's the theory. Here's Mr. Santiago again:
Give underpaid workers their real wages and what will they do with it? They will spend all of it. They will buy food, clothing, creating a demand for goods and services. The effect on the economy would be very fast, similar to the stimulus packages,” he said in a news release.

“Except that unlike giving money to the rich, who may buy paintings and other luxuries that create nothing, the poor will 100 percent buy useful things that create local demand for goods and services available locally.
Giving workers "their real wages" could mean allowing the market to determine their wages. The nominal wages can go up, or they can go down. This is not what Mr. Santiago means. He means only raising nominal wages even if we have an oversupply of labor.

Most likely, this is what happens when the nominal wages are increased in this environment with a labor surplus: An increase in the wages is an increase in production costs. The price of products go up naturally and as they rise, the demand for them goes down. To stay profitable, that is, to stay in business, the business owner will lower prices up to the point where he can still make a profit, but as soon as he starts losing money he'll start laying off workers or cutting their work time or close shop. A general increase in nominal wages also means that prices of production inputs also increase. There will be a general increase in prices such that the worker's 100 pesos, instead of being able to buy 2 kilos of rice, can buy only 1 kilo. The effect is a decrease in the real wages in spite of the increase in nominal wages. And since businesses are cutting costs to make a profit or closing down, there will be an increase of workers working, say, 4 hours instead of 8 as well as an increase in the ranks of the unemployed since a lot of businesses won't be able to hire workers at the mandated wage. There will be a general slowdown of business activity and a general deflation as businesses default on their loans and banks tighten up.

So no, increasing the nominal wages does not mean an increase in the real wages. To increase real wages, we need to get more people working, and more people producing stuff. We need to stop destroying the value of our currency by inflationary 'stimulus packages'. We should let deflation happen instead of fighting it. True, deflation might create a downward pressure on nominal wages but if it results in an increase in the purchasing power of the workers' peso, then that's a good thing. Mr. Santiago is correct in saying that government stimulus packages only help the banks (and government crony corporations, I might add), but mandating businesses to increase worker wages also has a detrimental effect on real wages. Businesses will be happy to bid up the price of wages if workers were in short supply, but that is not what we have.

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