/ 27 January 2016

Wages and productivity even out

Burger asks whether real wages have increased significantly over time
Burger asks whether real wages have increased significantly over time

In what seems to have become an annual South African ritual since 1994, labour unions make double-digit wage demands during wage negotiations, typically in a single-digit inflationary climate.

Employers then insist that wages cannot increase by more than the rate of inflation plus productivity growth, for doing so would decrease international competitiveness and thus increase unemployment.

What has been the outcome of this ritual? Have real wages increased significantly over time, relative to productivity? Or have they fallen behind?

This article covers the period from 1982 to 2015. This is long enough to include the formation of Cosatu in 1985, the major changes to the labour relations system as well as the opening up of the economy to international competition after 1994.

Have real wages increased continually or have there been sporadic upward shifts relative to productivity over a selected period? This is relevant because sporadic shifts might indicate the effect of cases of where there have been significant increases in labour bargaining power.

For instance, the boost to labour unions’ muscle when Cosatu was formed, or when new labour legislation was enacted after 1994, could have pushed real wages significantly higher than any productivity trend.

Alternatively, when the economy was exposed to full international competition in 1994, instead of increasing, real wages could have decreased relative to productivity as firms cut wages to improve competitiveness.

If so, such cuts might reflect labour’s weak or weakening bargaining power. If such cuts did not occur, it could indicate that labour unions prevented real wages from being cut, relative to productivity.

In another scenario, firms may have offset or counteracted “excessive” real-wage agreements by ways to reduce the total cost of wages at a later stage. An example of such measures is the implementation of labour-saving, capital-augmenting technology.

The size and effect of labour unions increased markedly in the 1980s following the labour market reforms recommended by the Wiehahn commission in 1979.

By 2015, based on data from the quarterly labour force survey in the third quarter of that year, the total membership of unions was about 3.7-million workers, which amounts to 33.8% of the workers in the formal, nonagricultural sectors.

Union membership is significantly skewed in favour of public sector unions: in 2013, for example, 69.2% of these workers belonged to a union, compared with only 24.4% of workers in the private sector. This might indicate that labour has relatively less power in the private sector.

Although South Africa has a long history of industrial and bargaining councils, the Labour Relations Act of 1995 extensively reshaped the coverage of bargaining councils in the new democratic dispensation. The legislation also allows the minister of labour to extend bargaining councils’ agreements on wages to all workers in an industry or area.

The number of workers covered by bargaining councils increased from 0.76-million in 1992 to 2.36-million in 2004. Thereafter the growth was slower, increasing to 2.52-million in 2010, before falling slightly to 2.5-million in 2013-2014.

In terms of the Basic Conditions of Employment Act of 1997, the minister sets minimum wages for 11 sectors. Some of the employees covered are farmworkers, domestic workers, workers in the hospitality industry, taxi workers and forestry workers. It is estimated that, in 2007, these sectoral determinations covered 17.2% of workers (excluding agriculture).

If unions, bargaining councils and the setting of minimum wages have a significantly positive effect on real wages relative to productivity, then one would expect real wages to:

  • Increase at a faster rate than productivity; or
  • Display one or more one-off increases (or jumps) in their level.

The converse would apply if firms succeeded in reducing real wages relative to productivity.

I considered indices of the aggregate average real wage and the total productivity in the economy, with the first quarter (Q1) of 1982 set equal to 100 for both indices. The average real wage was calculated using wage data from the various labour surveys of Statistics SA, and the average productivity was calculated as aggregate gross value added divided by the number of workers.

The graphic shows these indices. In the 1990s, real-wage increases on average outstripped increases in productivity: by 1998 the real-wage index reached 120, whereas the productivity index was still at 105.

But in the 2000s wage increases were lower than the increases in productivity, so that from 2008-2009 the two indices have moved roughly together. Thus, on the face of it, when one considers the full period, it does not seem that real wages have increased faster (or slower) than productivity.

The effects of different factors need to be untangled to understand the relative behaviour of real wages and productivity. A more formal statistical analysis enables this to some extent. To estimate the short- and long-run relationship between real wage and productivity, I used an econometric time-series model, which also allows for one-off shifts in the relationship to occur. The method of analysis is flexible enough to deal with structural changes during the period.

A first step is to analyse the direct long-run, or underlying, relationship between real wages and productivity by taking other factors and shocks out of consideration.The analysis shows that over the full period (1982 Q1 to 2015 Q1) there is a one-to-one relationship between real wages and productivity: on average, a 1% increase in productivity has been associated with a 1% increase in real wages. This means average real wages have changed in line with changes in per-worker productivity. This outcome is what standard economic theory would predict for labour markets that are functioning fairly well.

Second, in addition to this relationship, other factors and shocks could have affected the behaviour of real wages relative to productivity. The analysis shows that in the 1990s there were four shocks that significantly shifted the level of real wages upwards relative to productivity. These occurred in 1992, 1994 and twice in 1998, as indicated by the vertical blue lines (see graphic). But these upward shifts were largely reversed by downward shocks in 2002 and 2007 (at the vertical red lines) that shifted real wages down, relative to productivity.

The macroeconomic analysis does not divulge the precise causes of the shifts, but one can reflect on particular events that may have caused them. The shifts of the 1990s may have been a result of stronger unions or the implementation of stronger labour laws. For instance, the transition to democracy in the early and mid-1990s also saw the political ascent of the ANC-South African Communist Party-Cosatu tripartite alliance and hence a strengthening of labour power.

Also, the real-wage upward shocks of 1998 occurred in the year after the implementation of the Basic Conditions of Employment Act. But their effects were short-lived and mostly offset in the 2000s, when the country faced stronger foreign competition. For instance, the rand appreciated in 2002-2003, 2007 and 2009; this might have served as an incentive for firms to become more competitive by curbing labour cost, particularly in 2002 and 2007, when international demand was still strong and firms could benefit from improved competitiveness.

Also note that there was no large-scale downward adjustment in real wages following the substantial opening up of the economy in the mid-1990s to foreign competition. Labour unions might have been too strong for firms to improve international competitiveness through lowering real wages.

All in all, there does not appear to have been any continual tendency for real wages to diverge from productivity, either by falling behind or by increasing out of line with productivity increases.

This is contrary to the conventional wisdom in both the labour union and business worlds. Upward and negative shifts (shocks) have affected real wages sporadically, but these have tended to cancel each other out over time.

It appears that the power of the unions may not have been strong enough to accomplish long-lasting upward shifts in the real-wage level, relative to productivity, or to cause real wages to increase continually at a rate faster than productivity.

On the other hand, unions appear to have been (and may still be) strong enough to prevent firms from systematically reducing real wages, relative to productivity. Significant reductions in real wages (for example, to increase international competitiveness) are not politically feasible in any case.

Philippe Burger is professor of economics at the University of the Free State. This article first appeared on www.econ3x3.org.