Minimum wages: The choices are not simple

Jeremy Seekings and Nicoli Nattrass warn that wage rates should not be set at a level that results in job destruction

What is at issue in the minimum wage debate?

27 November 2014

Most contributions to the emerging debate on a national minimum wage in South Africa generate more heat than light by misrepresenting the difficult choices facing any policy-maker concerned with poverty and inequality.

Participations in the debate such as COSATU's Neil Coleman (including Business Day, 22 August; Daily Maverick, 10 November; or as quoted in Mail & Guardian, 14 November) try to simplify the choice such that anyone concerned with South Africa's high rates of poverty and inequality would support COSATU's demands for a high national minimum wage. Unfortunately, the choices are not as simple as Coleman - or Gilad Isaacs and Ben Fine (Daily Maverick, 26th November) - would have us believe.

There are three main positions on the national minimum wage issue. The first, advocated by the Free Market Foundation, is that any regulation of wages should be opposed, in part because wage regulation necessarily inhibits economic growth and job creation. In this view, the existing sectoral minimum wages set through the Employment Conditions Commission (ECC) (under the Basic Conditions of Employment Act) or by the Minister of Labour through the ‘extension' of collective agreements between employers and unions in bargaining councils (under the Labour Relations Act) are bad, and the prospect of a national minimum wage is even worse.

The opposite argument, made by Coleman (and COSATU), is that a national minimum wage should be imposed, and the minimum should be set between about R4,500 and R6,000 per month. Coleman argues that this will not only reduce the exploitation of lower-waged workers but will also generate job creation through consumption-fuelled growth.

There is however a middle view, to which we subscribe. In this view, wages should be regulated in a context such as South Africa, but the level at which wages are set should take into account effects on employment. Wage regulation might include a national minimum as well as sectoral minima. But minimum wages should not be set at a level that results in job destruction such that wages are raised for an ever-shrinking group of workers while unemployment grows. This would be likely to increase rather than reduce both poverty and inequality.

This middle position on the minimum wage issue differs from the first (free-market) position in that it endorses wage regulation. It differs from the second (Coleman) position in that it takes seriously the concern that setting a high national minimum wage might result in job destruction.

The real debate is between the middle position and the Coleman position. The tough decision is not over the principle of a national minimum wage, but over the level at which such a national minimum wage should be set, and the procedures for setting that minimum.

The difference between the Coleman position and the middle position corresponds to the difference between the logic of minimum-wage-setting under the Basic Conditions of Employment Act and the logic under the Labour Relations Act (LRA).

The Basic Conditions of Employment Act requires the ECC to take into account employment effects when recommending a sectoral determination regarding minimum wages. In late 2011, the ECC proposed that the minimum wage in agriculture be set at just over R1,500 per month from March 2012. In the wake of dramatic farmworker protests, the ECC proposed in 2013 a higher minimum wage of almost R2,300 per month (or R105 per day).

The ECC recommended this increase on the basis of new research that suggested that the increase would not lead to extensive job destruction. The ECC decided against raising the minimum wage to the level of at least R3,600 per month (i.e. R150 per day and a six-day week), as demanded by striking farmworkers, because it assessed that raising wages to that level would result in massive job destruction.

Anxious about the possibility of job destruction, the Department of Labour took the unprecedented step of allowing employers to apply for exemption from these minimum wages on the grounds of unaffordability. It is not clear how many exemptions were submitted or approved. But it seems that the employment effects might be higher than expected. When the ECC considers a new sectoral determination, it will no doubt take into account the effects that its previous sectoral determination had on employment.

The Labour Relations Act, in contrast to the Basic Conditions of Employment Act, provides for minimum wages to be set with little consideration of ensuing job destruction. First, unions and employers' associations - often dominated by the larger, more capital- and skill-intensive employers - negotiate collective agreements in bargaining councils. A collective agreement is binding only on those employers who are party to the agreement. But the Minister of Labour can - and under some circumstances must - ‘extend' this to all employers.

In this system, trade unions and large employers pursue their own interests. They typically do not raise wages to levels that would destroy their own businesses and jobs, but they can and do raise wages which, when extended by the Minister of Labour, result in the closure of other firms and the destruction of other workers' jobs.

Coleman wants a new system whereby a national minimum wage is set without worrying about employment effects. This might be because he is not as concerned about job destruction and unemployment as he is with the wages paid to the employed. Or it might be because he thinks that there would be no effect on employment. In his various writings he does not make it clear which of these he believes.

He dismisses as a myth the assertion that a national minimum wage would result in job destruction. We do not disagree with him on this: A national minimum wage set at the level of the ECC's current minimum wages in sectors such as domestic work or agriculture would probably not result in significant job destruction.

But Coleman avoids stating explicitly whether he believes that a national minimum wage of between R4,500 and R6,000 per month would result in any job destruction. Isaacs and Fine also avoid saying whether they believe that a national minimum set at this level would destroy jobs. Both Coleman and Isaacs/Fine however imply that high minimum wages would be good for employment (without considering why wages should not be set much higher than the R4,500 to R6,000 band).

In advocating a national minimum wage of between R4,500 and R6,000 per month, Coleman is implicitly criticizing anyone who has supported minimum wages lower than this on the grounds that higher wages would destroy jobs.

Consider the case of agriculture: If Coleman had his way, the minimum wage in agriculture would be approximately doubled. This implies that he thinks that the ECC was wrong to assess that setting wages in agriculture higher than R105 per day would result in job destruction. Indeed, Coleman presumably thinks, every single sectoral determination made by the ECC has been wrong: minimum wages could have been set at higher levels without any loss of jobs!

Consider even the case of the clothing sector. Coleman proposes setting the national minimum wage higher than the minimum wage currently in force in the clothing sector (under the LRA) and supported by the South African Clothing and Textile Workers Union (SACTWU), large firms (including union-owned firms) and the Minister of Labour.

This implies that Coleman thinks that SACTWU (and the Minister of Labour) were wrong to worry that SACTWU's own members would lose their jobs if wages were set at higher levels. If they had raised minimum wages even higher, Coleman and Isaacs/Fine seem to think, then jobs would have been created, not lost.

So, who is right? Coleman and (it seems) Isaacs/Fine, who appear to think that wages can be raised dramatically without job destruction, or the ECC (or SACTWU), whose recommended minimum wages were lower than R4,500 per month because they worried about job destruction? Coleman and Isaacs/Fine cite two sets of evidence in implicit support of high national minimum wages. Neither is nearly as compelling as they would like us to believe.

First, they cite research in the USA and to the experience of Brazil, which suggests that in those cases, modest increases in minimum wages did not result in significant job destruction. The difficulty with this research is that the USA and Brazil are low-unemployment economies, while South Africa has the highest unemployment rate of any economy except a few recovering from the devastation of war. In the USA and Brazil, most poor people work. Raising the wages of the working poor in growing economies, with ‘tight' labour markets, does indeed reduce poverty.

These countries' experience is not appropriate to South Africa. The case that is appropriate is Mauritius. In the 1970s Mauritius suffered from high unemployment. Acting on the recommendations of the great (and progressive) economist James Meade, Mauritius encouraged low-wage job creation. The Mauritian government waited until unemployment had dropped - i.e. the labour market had tightened - before raising statutory minimum wages.

Secondly, Coleman and Isaacs/Fine point to research by Haroon Bhorat and his colleagues in the Development Policy Research Unit at the University of Cape Town, on the effects of sectoral minimum wages set by the ECC in the early 2000s. The research examines minimum wages set at levels very much lower than the minimum proposed by Coleman, by an institution (the ECC) required to take into account employment effects. It is not clear, therefore, how readily these experiences can be applied to the proposed massive increase in minimum wages.

Moreover, Coleman and Fine/Isaacs do not do full justice to the research by Bhorat et al., which is rather more nuanced than Coleman and Isaacs/Fine acknowledge. Most ECC sectoral determinations cover non-tradable sectors, i.e. sectors (such as private security, domestic work, retail and restaurants) which do not face competition from imports. This means that the likelihood that modest wage increases would result in major employment losses was low.

Moreover, many of these sectors were ones where the employers or customers were enjoying rising real earnings and the demand for labour was buoyant. In most of these sectors there was a modest decline in employment (in terms of reduced working hours) but not job destruction. In these sectors, the arguments for raised minimum wages need to be taken seriously by anyone in the middle ground of the minimum wage debate.

The evidence points to a rather different conclusion with regard to tradable sectors, notably agriculture. South African farmers - whether they are producing grapes for wine or lambs for slaughter or sheep for wool - compete with farmers elsewhere in the world for foreign and local markets. Case-studies in different parts of the country as well as Bhorat et al.'s analysis of national data suggest that the original (2002) sectoral determination in agriculture raised wages modestly and improved compliance with non-wage regulations, but also resulted in a significant reduction in total employment and/or hours worked. In the forestry sector, also, Bhorat et al.'s research found that the sectoral determination did not lead to any observed improvement in total earnings.

The effects of higher minimum wages vary between sectors according to factors such as their exposure to international competition, the possibilities for mechanisation, and the incomes of employers or customers. It seems that setting minimum wages in non-tradable sectors probably resulted in higher real wages that more than offset reduced hours of employment, but in tradable sectors the negative employment effects were much larger.

One South African study (Pauw and Leibbrandt, 2012) found that, overall, minimum wages lead to significant job losses among unskilled workers. Minimum wages may have reduced wage inequality in terms of hourly wages, but perhaps not in terms of total wages, and probably at the expense of diminished demand for unskilled labour.

The same logic applies to the effects of raised minimum wages in the clothing sector (under the extension mechanism provided by the LRA). SACTWU itself recognizes that higher wages lead to job destruction, and has moderated its wage demands in order to protects its members' jobs. What the empirical evidence suggests is that we are right to worry about ‘negative employment effects' (i.e. job destruction), especially in tradable sectors.

There is more scope for higher minimum wages in some sectors than in others. This suggests that minima should vary between sectors, i.e. that the ECC model should be amended but not discarded. A low national minimum should be set at the level of the lowest sectoral determination, and higher minima might be set in other sectors if the ‘employment effects' (i.e. ensuing job destruction) are assessed to be modest.

Arguing for a uniformly high national minimum wage seems to us to entail what might be called ‘unemployment denialism', i.e. the denial of the fact that poverty in South Africa is the result primarily of massive unemployment, and the assertion instead that the poverty is due primarily to low wages (as is the case in Brazil and the USA).

Finally, Coleman and Isaacs/Fine might invoke the magic of the macro-economic argument that paying workers more money would fuel economic growth and job creation. There are many reasons for doubting this argument. First, if higher wages result in job destruction, then the net effect on spending power will be reduced, and perhaps even negative.

Secondly, recent economic growth in South Africa has been driven primarily by increased consumption, but this growth has generated only modest employment growth. Indeed, the ratio between employment growth and economic growth in South Africa is small compared to similar economies. Consumption-led growth has not led to significant employment growth in South Africa, but Coleman would have us believe that raised minimum wages would lead to consumption-led growth and job creation in future.

The vague possibility of unprecedented, growth-led job creation hardly seems to warrant setting a national minimum at a level that would destroy jobs in sectors such as agriculture, destroy entirely sectors such as clothing, and would reduce the possibility of any labour-intensive sectors growing in future.

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The views expressed in this opinion piece are those of the authors. No inference should be made as to whether GroundUp endorses or opposes these views.

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