Labour costs not constraint to economic growth

I read How South Africa Works – And Must Do Better and found much good in it, although there are arguments with which I disagree and feel need more debate.   Authors Jeffrey Herbst and Greg Mills offer clear answers – concise and understandable. Their honesty is refreshing; they write it like they see it, and don’t pull any punches. I will try to reciprocate in kind.

How South Africa Works  is a work of political economy written in an an accessible way. It deserves to be widely read and could be helpful in improving the level of economic debate in this country. Much like Joe Sudwell’s How Asia Works,  is should be taken seriously.  So what are the strengths of their argument?

l Their view that South Africa’s key challenge is unemployment and that job creation is slow is completely correct. Unemployment is undoubtedly the most urgent economic issue facing our country and any attempts to solve this problem are entirely welcome;

l Their focus on increasing jobs in the private sector is also correct. Most of our existing jobs are provided by business enterprises, and the growth of private sector investment, output and employment will be essential to solving the unemployment problem;

l Herbst and Mills’ sector approach is also essential. By devoting separate chapters to agriculture, services/tourism, manufacturing and mining, they are able to identify sector-specific constraints on business growth and job creation;

l I also found their case study approach useful. These examples help to bring issues more to life than some of the more academic texts. The highlights on things that are already working in practice was also useful;

l I think the focus on the unintended consequences of government regulations is also broadly correct. This is an area that received attention in the National Development Plan and government is doing work in this area with the World Bank, among others.  I agree this work needs to be tackled more urgently and decisively. There are steps currently underway by government to address this;

l In general I also agree on the points on “policy incoherence” (though they don’t use this term). We simply cannot afford different economic policies that pull in different directions. Rather we need a set of economic policies that are mutually reinforcing. This matter needs far more serious attention;

l Their concluding chapter with policy proposals is also useful. In particular I agree with the proposal that “new venues be established to communicate with business”  where creative problem-solving can take place between senior government and business leaders.

I would suggest these problem-solving sessions be organised by the various sectors since, as the authors have demonstrated, many of the obstacles to business expansion and job creation are sector specific.

One of the core arguments of How South Africa Works is that “the poor economic performance of South Africa can be directly tied to the high cost of labour, and the difficulty of hiring and firing”.

Here I think Mills and Herbst overly reduce our economic problems to those of the labour market, and underplay other structural constraints to growth.

It is important that we engage on these issues rather than simply accept or dismiss the arguments depending on whichever side of the ideological fence we might sit. As the old adage goes, for employers the costs of labour are always too high and for workers (and their representative trade unions) the costs of labour are always too low.

In engaging on these issues, it is important to ask two fundamental questions. First, are our labour costs really high? And second, is the structure and functioning of the labour market really our core binding constraint?

I will start with the costs of labour. Obviously since 1994 labour costs have risen. This follows given that the apartheid economy was built around the super-exploitation of labour and there was little to no protection of worker rights pre-1994.

Unfortunately, the evidence cited in  How South Africa Works does not compare unit labour costs with other countries in real money terms, but rather looks at the rate of index increase (with South Africa having a higher rate of increase than, for example, the Organisation for Economic Co-operation and Development countries since 1970).

Current discussion on labour costs is a sensitive and emotive issue. Certainly, the majority of our workforce who are low paid, earning just a few thousand a month, would not agree that they are overpaid, especially when compared to the exorbitant salaries of CEOs.

The matter of intra-firm income inequality is a real issue which we must confront when engaging on these issues. We must also remember that unit labour costs are usually calculated using total employment incomes in an economy – that is, the aggregate of all employees from highly paid CEOs to the lowest paid workers.

So we need to interrogate more carefully the question of which income segments are responsible for the high labour costs. Are these higher costs primarily for the low skills components of production, or are they for the more skills intensive levels (possibly because of skills shortages)?

Linked to this point, the authors pay no attention to the distribution of incomes from employment. Specifically, they fail to make the crucial distinction between average employment incomes (total incomes from employment divided by the number of employees) and modal employment incomes: the typical income – what most people are paid.

In South Africa the majority of employees are low-paid, consequently the average wage income is much larger than the modal wage income. The work of Professor Martin Wittenberg at UCT is useful. His detailed statistical work shows that since 1994 average wages have grown far more than modal wages.

The second question I would pose relates to the authors’ argument that the structure and functioning of the labour market is our core binding constraint. This needs to be dealt with at both the level of the national economy and the firm.

At national economy level, the authors pay insufficient attention to the structural constraints to growth – outside of the labour market.

Here we need to highlight our over-dependence on commodity markets and financial inflows as our two key sources of growth. This has left us overly vulnerable to the vagaries of international markets.

Economic transformation must primarily be about transforming this expired growth model, re-industrialising and diversifying the economy towards new domestic sources of growth.  How this is to happen unfortunately gets too little focus.

The authors also underplay the extent to which inequality is a constraint to growth. On several occasions they suggest inequality of household incomes in South Africa is a consequence of unemployment.

This is not altogether true. Income inequality derives from three, fairly equal sources: wealth inequality, employment income inequality and unemployment.

This is important because recent research by the World Bank, International Monetary Fund and OECD has acknowledged that growth is retarded by high levels of inequality.

I don’t think the authors mention this, or how income inequality is reproduced over generations, both by wealth inheritance and the reproduction of employment inequalities through class differences in education provision.

Turning to firm level, we need to further interrogate whether wage levels are the decisive factor that determines firm competitiveness.  As Jose Gabriel Palma pointed out last year, the success of East Asian developing economies was not just about cheap labour, but had more to do with sustained levels of high productivity (which leads to lower dollar unit costs).

Higher productivity depended on a range of other factors (beyond just labour costs), including locational advantages (proximity to raw materials, inputs and markets), state of infrastructure and logistics, costs of other inputs (energy etc), skills and training costs, management competency, technological developments and so on.

Despite the points I have made disagreeing with the authors’ assertion that the labour market – and particularly high wage levels – is the decisive constraint on growth and jobs, I think, as government, we should continue to review the functioning and efficiency of the labour market. Without doubt, our labour relations regime is in need of a major overhaul (as suggested in the NDP and by international organisations such as OECD) and we are currently looking at some of the constraining regulatory aspects of the labour market.

I totally agree with the book’s subtitle And Must Do Better. Yes, we could, we can and we must do better! We are stuck in a low growth trap and we need to infuse a sense of urgency in dealing with our predicament. But I think we need deeper analysis on why we are in this low growth trap, and depending on our diagnostics, how we can get out of it. Here Herbst and Mills make an important contribution.

It would also have been useful for the authors to locate their work and arguments within the current debates on the South Africa economy.

Herbst and Mills are correct to emphasise: “SA has a deep vein of business people who are keen to build world-class firms.” We have much to build on and we should not forget this. We are well aware of some of the deficiencies in our collective bargaining structures and platforms for engagement such as Nedlac.

In line with the NDP, we are currently looking at new ways of partnering with the private sector to address the core constraints in different sectors.