The Effect of Wage Increase on Inflation

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According to News24, on the 19th of May, Deputy General Manager Tahir Maepa an official of the Public Servants Association of South Africa, which represent about 238,000 workers, “revealed they want an above inflation increase of 12% which all unions initially demanded and furthered revealed the association would not sign the deal”. While the Central Bank governor of South Africa, Lesetja Kganyago has warned that “the inflation rate will start rising due to tax increases and high salary demands, inflation will stay close to 5% until at least at the end of 2020, according to the regulator”.

In the debate over minimum wage, people often become distracted by their inner altruism and ignore the logic behind the economic laws that govern labour markets and the macro-economies of a country.

Is the perennial agitation for minimum wage increase justifiable? This is the question many people have been asking. From an economic point of view, continuous wage increase is not justifiable. In fact it is detrimental to the economy. There are two main consequences of continuous wage increase, general and persistence rise in the price of good and service, and reductions in the number of jobs available. Frequent increases in wage have the tendency to become an inflationary shock that is associated with sudden increase in the general price of good and services. This is what has been happening since the agitation for wage increase becomes an annual event. At one hand, the demand for wage increase force producers to increase the price of good and services in order to cover the cost of wage increase, what economist called wage-cost push inflation. On the other hand, the mere expectation of increase in wage makes traders’ mouth to salivate on the coming prospect of increase purchasing power on the part of workers. Therefore, makes traders to move the prices of good and service up.

Advocates argue that raising the minimum wage would help poorer citizens provide for their families and lift them out of poverty. It is true that minimum wage regulations typically apply only to poorer, lower-skilled workers. It is not true that raising the minimum wage will help them. The money that companies use to pay higher wages would reduce profit margins of the companies.

Maintaining profit margins is a serious pursuit for firms because profits allow firms to innovate, expand and stay alive in a competitive market. When confronted with a mandatory minimum wage, companies must often increase the price of their goods or services to preserve profit margins and so ensure their continued existence. Therefore, broadly raising the minimum wage would increase consumer prices, that is, inflation.

Inflation, unfortunately, hurts the poor far worse than it hurts anyone else. The poor are more likely to live from salary to salary, and inflation means that prices would rise. Prices would certainly rise much faster than wages will adjust — especially a minimum wage set by the government. This means that the poor are able to buy less of what they need to survive as inflation rises. What good are higher wages if purchasing power falls?

Consequently, the very people who were supposed to benefit from an increase in the minimum wage are the ones who are most hurt by the ripple effects of this policy. This seemingly progressive price floor set by the government then turns into a very real regressive consequence for the poor.

Second, let me say that raising the national minimum wage does not increase Gross Domestic Product (GDP). If it did, you would no longer be able to see a “minimum” wage at all, because every country in the world would be continuously raising this minimum in an effort to stimulate economic growth.

We have all heard the claims that a higher minimum wage would benefit the economy by giving workers more money to spend, thereby increasing aggregate demand and GDP. Raising the minimum wage does not increase aggregate demand at all, because any extra money paid to workers would have merely come from the firms or consumers in the form of higher prices.

Finally, raising the minimum wage would put a strain on South Africa’s already thin labour market. By the laws of supply and demand in the labour market, settling a wage above the current inflation rate will cause some people to be forced to work fewer hours or lose their jobs.

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Simply put, as labour becomes more expensive, companies are more likely to substitute technology for workers, more likely to hire fewer workers for longer hours, more likely to offer fewer benefits, and/or limit training in an effort to control other costs associated with labour. It is also worth noting that the workers most at risk of being let go or having their hours reduced are lower-skilled workers.

Truly workers deserve something better than what they are getting under the present circumstance. But should that be only through increase in money wage? Why should workers not demand for improve working condition so as to boost workers’ productivity? Continuous issuing of threat of strike on wage increase without commiserate demands for government to do things that will help people that are not on government pay will undermine unions causes in the long run. South Africa’s labour needs to work harder to represent themselves as champions of public services rather than simply as defenders of their pockets.

Instead of focusing on raising the minimum wage, government should focus on improving the structural problems in South Africa that have caused the market equilibrium wage to be so low: poor education and training, low population mobility and regulations on investment and innovation. As the economy grows, so too will wages.

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