Minimum wage increase and unintended consequences

Prime Minister Ahmet Davutoglu promised they would increase the minimum wage rate to TL 1,300 (approximately $450) from its current level of TL 1,000 ($350). A 30 percent increase is indeed a significant increase. Business associations have started to complain about the potential impact of that increase on their bottom lines. However, the voices of the representatives of small and medium-sized enterprises (SMEs) are louder than those of the associations of big businesses, like the Turkish Industrialists and Businessmen’s Association (TUSİAD). That makes sense since the number of workers earning the minimum wage is very limited in big enterprises.

Paying the minimum wage, or even lower than the minimum wage, is a very common practice among SMEs. According to official statistics, about 40 percent of the total workforce is earning the minimum wage. That ratio is much larger when compared to similar countries. I guess the tax evasion motivations of business owners paying minimum wages seem to be bigger than the reality. However statistics based on survey data do not provide a very different picture. The opponents of the wage hike claim that there will be many severe ramifications: a fall in the competitiveness of local companies in the global market; an increase in the unemployment rate; an increase in unregistered employment; an increase in bankruptcies; an increase in inflation; and finally an increase in the current account deficit (CAD). Thus, they are demanding that a significant portion of the burden of this rate hike be shared by the government or, even better, the plan be abandoned altogether. Many of these complaints and claims are legitimate and highly likely. Since there are many accounts elsewhere of these potential costs, I want to concentrate on the benefits.

I believe the benefits would outweigh all of these potential costs. First I should emphasize that the labor share of national income is the lowest in Turkey among Organization for Economic Cooperation and Development (OECD) countries, and it is getting smaller. Even in Mexico, the labor share is bigger compared to Turkey. Because the situation cannot continue this way, politicians from virtually all political parties had promised to increase wages. Now it is time to act on that promise.

In many developing countries a new trend has emerged that is similar to the so-called dual economies of former colonies. Two separate types of companies coexisting in the same country: one has the necessary technology, know-how, quality control and skilled workforce to compete in international markets, while the other lacks all of those but can somehow satisfy the local demand. In Turkey, I can say a similar situation emerged, especially after the Customs Union Agreement in 1995. Before the agreement was signed, there were many gloomy predictions about the total collapse of local producers. According to them, once the protection provided by high tariff rates came down, no company would be able to compete with international giants.

It turned out those predictions were almost completely off point. Most of the large Turkish companies showed a great deal of adaptability to the new reality and greatly improved their quality, productivity and competitiveness. Not only did they not go bankrupt, they also increased their exports, revenues and profits by a great magnitude. However due to complex dynamics, many SMEs were able to survive, even with much lower technology, know-how, managerial ability and productivity. I believe one of those dynamics is the availability of cheap and abundant labor.

The marginal productivity of workers in those two different types of companies is naturally very different from the other. Thus their wages are substantially different and, maybe more importantly, still diverging from the other. This is one of the factors behind the increased inequality in income distribution. I believe it is neither desirable nor sustainable. A sudden increase in the minimum wage can create a big enough impact to reverse that trend. According to my optimistic projections, SMEs will undergo a transformation similar to the one experienced by big businesses after the customs union. In more realistic scenarios, many workers will switch to the unofficial sector and be paid less than the official minimum wage rate. The availability of Syrian refugees and the lack of determination by the government to clamp down on the informal economy increase the likelihood of that pessimistic scenario.

There will be many unexpected benefits of increasing wages. I am going to list just a few of those potential impacts. For example, David Meltzer and Zhuo Chen have shown that decreases in the real minimum wage in the US increase the prevalence of obesity by increasing the availability of fast food restaurants and resulting in falling prices within them. I am not sure whether an increase in the wage rate will have the desirable effect of reducing the obesity rate in Turkey. However, I hope it will reduce the rents transferred to landlords. I believe most rents in Turkey are indeed “rents” in the economic sense. They are the most unproductive factor among the factors of production. The exorbitant rents obtained by landowners disturb the investment motives and democratic structure of local politics. Lastly, increasing the minimum wage will certainly reduce the poverty rate among the working population and its political, social and economic consequences.


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