Are Low Wages Determined By Low Productivity?

Written by Dr Carmelo Ferlito

First published in Business Today on 6 December 2023

By Dr Carmelo Ferlito CEO – Center for Market Education- In the recent debate about wages in Malaysia, a theme recurs like a mantra: productivity. According to several analysts, it seems that wages in the country tend to be low because productivity is low (or, to use a jargon dear to the Classical economists: wages cannot command enough additional product, so they do not grow). Moreover, the government is moving in the direction of introducing automatic wage adjustment mechanisms, linking remuneration increases to productivity (for the moment, and rightly so, only on a voluntary basis).

The first point I should raise here is that, as any other quantity in the economy, wages are not high or low: they can be lower or higher when a term of comparison is chosen; in fact, the expressions “low” and “high”, because of their subjective nature, have little meaning for an adequate scientific analysis. For a proper judgement about the matter, we should answer two different questions. The first: are wages actually low, at least in the sense that, over a certain period of time, they
grew at a slower pace when compared with the general level of prices? The second analysis, instead, is to understand how wages are determined in the labour market.

Let us begin with the data. Are today’s wages higher or lower? Well, it very much depends on which year we choose as starting basis, as Dr Apurva Sanghi rightly pointed out in a recent conversation. Using data from DOSM and the World Bank, we find out that, if the starting point is 2015 (2015 = 100), then in 2022 median wages were 124.77, mean wages 129.24 and consumer prices 112.98. Therefore, averagely Malaysians are today earning more, in real terms, than in 2015. Productivity, instead, was 113.72: wages grew faster than productivity, as measured by the Malaysia Productivity Corporation (MPC).

But what if our reference point is the pre-lockdown? If 2019 = 100, then in 2022 median wages were 99.17, mean wages 99.74 and consumer prices 104.82. As I argued elsewhere, thus, the Great Lockdown made people poorer in the sense that monetary injections in the form of expansive fiscal and monetary policies created inflation and wages were unable to keep pace with the government-induced increase in prices. They also did not keep pace with productivity (if 2019 = 100, 2022 = 101.83).

Let us move to the second point, which is strictly related to the mantra of productivity. One of the first lessons young economics students should learn pretty quickly is that there is no element of economic life which can be said to be determined by a single factor. Indeed, simple chains of causation are very difficult to identify and may be extremely misleading. How are wages thus determined? As every price, wages depend on the interaction between supply and demand; and it is important to clarify that demand and supply means not just how many jobs are offered (demand) and how many workers are available (supply).

Quantity is just one of the determinants of supply and demand. Therefore, productivity can be, at best, one of the elements entering the complex formation of supply and demand. How? Well, we need to answer with another question: what is the main determinant of investments, intended as the amount of money that enterprises spend in order to set up a production process which, in time, will give birth to a specific product or service? Profit expectations. Allow me a brief digression: this is the reason why extremely low interest rates may be ineffective in stimulating investments; no matter how low interest rates are, if profit expectations are even lower, then investments will not emerge.

Therefore, investments decisions are based on profit expectations and, in particular, on the selling price which is expected (and expectations can be disappointed) to be gained from selling a specific product or service. Productivity is an element entering considerations about investments: how many workers do I need in order to obtain the necessary selling quantity which allows me to obtain a profit? Surely, a certain quantity X can be obtained with a smaller number of productive workers or with a higher amount of less productive workers, ceteris paribus. Specifying everything being equal is extremely important, because not all production processes are the same and there are situations in which certain choices are possible and others in which they are not. Furthermore – it must be added – productivity, at micro level, is very difficult to be calculated: while the monetary value of the output of a certain firm can be divided by the total number of workers, thus obtaining the average productivity, the contribution of each specific worker remains a much smokier entity to be grasped.

Finally, even when such a measurability would be possible, less productive – and cheaper – workers may be preferred if the additional value to be paid for more productive workers is marginally higher than the value of the additional output.

In a nutshell, productivity matters but it does so in a much more intricated way than we are used to think. It enters considerations about investments decision, contributing therefore indirectly to salary determination, but within a labour market in which supply and demand are determined by multiple factors which are also extremely different in time and place. And, finally, we have seen that a univocal relationship between wages and productivity is not emerging from the data.

The economy remains an extremely complex system made of interacting and unpredictable human beings. Univocal relationships do not exist and too a rigid and forced from above link between wages and productivity may backfire. This is why policymaking is more an art than a science.