Should Malaysia force wages to rise through direct wage policy intervention?

Too-low wages and the ‘squeezed middle’

Here are some of the widely publicised statistics. The median monthly wage in Malaysia is RM2,600 (using data based on employed workers in the formal sector). This means half of the working population in the country makes less than this amount each month. To be among the top 20% wage earner, one only needs to make above RM5,500 a month. The remaining middle group (30%) earns a monthly wage of between RM2,600 and RM5,500.

Over the past decade, the minimum wage has risen quite sharply — from RM900 in 2013 (when the Minimum Wage Order was introduced) to RM1,500 currently, or by about 67%. Wage increases for all other workers have been far slower, however, in the absence of policy directly addressing the rest of the wage spectrum.

Chart 1 shows a sampling of median wages by occupation and their respective wage growth between 2010 and 2019. As we noted, the wage increase for the lowest-paid workers (bottom 20%) has been the highest (roughly 12% compound annual growth based on our sample), thanks to rising minimum wage. But the compound wage growth was much lower for the majority, roughly 5% a year on average, before picking up to about 8% a year for the highest-paid workers (top 20%).

See also: Why y-o-y real wages in the US may be rising, yet its standard of living may have fallen — a statistical mirage

In particular, the rate of wage increases for the middle group — the 30% of workers earning between RM2,600 and RM5,500 monthly — was the lowest. As a result, we have an increasingly “squeezed middle” — faced with slow wage growth and, at the same time, missing out on most of the government assistance programmes. These are people likely to be living in urban-semi urban areas, incurring a higher cost of living for housing and transport. For instance, it would cost more to own private vehicles, given poor public transport connectivity.

Bank Negara Malaysia pegged the living wage for an adult living in Kuala Lumpur at RM2,700 a month back in 2018, which is no doubt higher today. The cost of living outside major cities would be lower. Nevertheless, the implication is that, left to market forces, wages and wages growth have been too low for the majority to maintain a minimum acceptable standard of living amid rising costs.

See also: Education was, is and always will be the great equaliser

Consequently, savings — and buffers against unexpected events/expenses such as during the Covid-19 pandemic — are too low and household debts too high. This is underscored by the consistent and sharp decline in the national savings rate (as a percentage of GDP), from a peak of 40% in 1998 to just 27% last year. For the average private sector wage earner, this implies scant savings out side of the mandatory 23% to 24% savings (employees plus employer contributions) in the Employees Provident Fund. (Of course, in reality, the actual savings for every individual could be very different.)

If the market has failed to raise wage levels in the past, the obvious solution, then, is for the government to step in — to force wages higher across the board with direct policy intervention. And it is not just to continue raising the minimum wage but pushing out further to encompass (possibly) the entire wage spectrum, including the middle-upper wage groups. Such progressive wage policies could include mandatory wage floors and/or annual increments for every sector, by skills and experience. Higher wages will translate into higher savings and purchasing power — and consumption to drive economic growth. Simple, yes. Yet, also terribly wrong. Why?

Don’t put the cart before the horse

For starters, while the low annual wage growth does need to be addressed, the perception that is being created from the above statis tics is misleading.

Yes, the average monthly salary for, say, an accounts executive position (with one to three years’ experience) increased from RM3,250 in 2010 to RM4,250 in 2022, or only 2.3% a year. Or that of a civil engineer with two to five years’ experience has risen at a similar clip, from RM4,000 to RM5,250. That is barely keeping pace with inflation, which was 2.2% a year, on average, during this period (again, let’s be honest: The actual inflation for the man in the street has been much higher than this official rate).

The thing is, this data provides only a snapshot of the job market at a particular point in time. Thus, we are comparing two snapshots taken 12 years apart. What it does not take into account is the wage mobility over this time frame. What if we could follow the career path of an individual? Does it change the story?

The real question is whether this accounts executive (or civil engineer) will stay in the same position the entire 12 years and is, therefore, in need of direct policy intervention to improve his financial situation. Or is this mere ly his starting salary, from which he will advance, say, to accountant in four years and finance manager in another four years? Currently, a finance manager (with six to eight years’ experience) can command a salary of RM10,000 to RM15,000 a month. In other words, the monthly salary for our accounts executive would have increased from RM3,250 to possibly as high as RM15,000 over the past 12 years. Clearly, his annual wage growth is significantly higher than 2.3%, if he had remained in the same position (see Chart 2).

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Unfortunately, there is no official available data for wage mobility, beyond statistics (which we have used in our example here) collated by recruitment agencies. And herein lies one of the biggest problems — our data does not capture “completeness”, be it of wages, incomes, cost of living and so forth. Indeed, we believe Malaysia has a large informal economy, where incomes are grossly under-reported. Case in point: Only one in five of the entire workforce currently pays income taxes.

Incidentally, much has been written about the very low median savings, of about RM8,100, in the EPF. To put this into context, the median age group is 31 to 35, meaning that there is time yet for this savings to grow, especially from wage mobility. Indeed, the average savings for members at age 54 was more than RM246,000 in 2021. Is this sufficient? Of course, having RM1 million is better and RM10 million even more so. We all want to sing like Whitney Houston or Taylor Swift, but that is wishful thinking. It is not going to happen. We need to be realistic and set realistic targets. The fact is that the average EPF savings for every age group have increased over the past 14 years (from 2007 to 2021), in both nominal and real terms (adjusted for inflation) (see Chart 3).

The point is, when we take into account the incompleteness of data and encompassing the bigger picture, the issue is different — and, therefore, the solution to raising overall wages in the country will also be very different. We wonder whether some of this skewed and “chosen” data is intentional with agendas. Let’s not put the cart before the horse.

Coming back to our accounts executive example, obviously, the number of higher-wage positions will be fewer, that is opportunities for career advancement. For instance, a company may have 10 accounts executives but only two accountants and one manager. So, rather than being fixated on raising the annual wage growth, the more important policy objective would be to increase the number of higher-paying jobs. How? By attracting more high-value investments. Direct policy intervention in the private job market, we fear, would have the opposite effect — it will more likely deter than attract investments.

Yes, there are examples in which wage policies have led to higher productivity and income levels. Singapore is often touted as the success case, where forced wage hikes provided the foundation in transforming its economy from one that is labour-intensive to one that is capital-intensive — but the process was far from smooth, and not without pain.

During its “Second Industrial Revolution” (1979 to 1984), the National Wages Council (NWC) recommended a general wage increase of 12% in 1979, 15% in 1980 and 12% to 16% in 1981. At the same time, the employer contribution rate to the CPF (Central Provident Fund) was raised progressively from 16.5% in 1978 to 25% by 1984. The objective was to increase labour costs by so much that companies were forced to replace low-skill, low wage labour-intensive industries with high-value capital-intensive ones. With wages rising much faster than productivity gains, however, Singapore suffered a loss of competitiveness in the global market, which contributed to the steep recession in 1985. The Advisory Economic Committee (formed in response to the recession) recommended broad-ranging cost-cutting, including wage freeze/cuts. In the aftermath of the recession, a more market-driven, flexible wage system was introduced, where wages are broadly based on productivity. Of significance, the wage hikes from 1979 to 1984 were complemented with adult education, training and retraining courses to upskill workers as well as other economic development programmes, including incentives for R&D, measures to attract foreign direct investment and the setting up of industrial training institutes.

Clearly, careful planning and execution are key, the failure of which could lead to disastrous results. And there are examples where direct government intervention led to a negative impact on the economy. For instance, Brazil has a minimum wage policy that is adjusted annually. According to a World Bank report, the minimum wage in Brazil increased by an average of 68% between 2003 and 2014. While this helped to reduce poverty and improve living standards for low-wage workers, the higher wages — that far exceeded productivity gains of only 21% over this period — led to rising costs for businesses. Competition in the country is low while the cost of doing business is high. As a result, investments and innovation declined, as did economic complexity and total factor productivity (TFP). Brazil became less competitive (of course, there are other contributory factors) and unemployment rose (see Chart 4).

Chart 5 shows the historical TFP for Malaysia. TFP rose marginally between 2013 and 2019, after minimum wages were introduced and progressively raised. But TFP rose far more significantly between 2001 and 2008, when there was no minimum wage policy. In short, there is no clear correlation between higher wages and productivity gains. Raising wages can increase TFP — but only if wages are based on outcomes or output. Raising wages in the belief that productivity can be forced up through higher investments by the private sector may be a myth — unless there are very clear policy instruments on accelerating investments and R&D, as well as raising the education and training of the workforce.

Firms cannot afford to pay more, with falling profitability and returns on capital

 A crucial factor for direct wage interventions to be successful is the talent, the workforce itself. It is time for an honest assessment — do we have the necessary skills and knowledge (quality and level of education) to step up productivity and justify higher wages? Otherwise, it would simply lead to a higher cost of doing business and, in the worst case, higher unemployment. Why? More on this later. As seen in Chart 5, our productivity gains have been muted in the last 20 years.

Even more critically, can firms afford to pay more? As we have written before, workers in Malaysia are lowly paid, but not underpaid. Wage increases have been slow, not because firms are taking a larger and larger share of incomes. In fact, their returns on equity capital (ROE) have been in a consistent downtrend in the past decade. Profitability — net margin for all companies listed on Bursa Malaysia — has been falling. (This is why stocks on Bursa have performed so poorly for so many years) (see Chart 6). Why? And why are there are so many low-paying jobs in the country? The median monthly wage of RM2,600 means that half of the working population is making less than this amount.

The most frequently given reasons are that businesses have failed to move up the value chain, staying primarily in the low value-high volume segments, with little branding power and intellectual property rights. They are therefore quite likely price takers in the global market. Against the backdrop of increasing competition from low-cost producers in newly emerging markets, it is not surprising that margins suffered. But, again, the question is why did they not move up the value chain?

We have written extensively on how Malaysia’s capital controls (in response to the Asian financial crisis [AFC]) hurt confidence and investments. The “low” ringgit peg at 3.80 to the US dollar and availability of cheap, predominantly unskilled foreign labour gave exporters “easy” profits in the beginning, negating the urgency to innovate and improve productivity. It encouraged the preservation of low-skill low-tech industries, limiting growth potential. We fell behind.

What is less frequently articulated, but perhaps the most important reason, is Malaysia’s endemic culture of rent-seeking. We have a captured economy, no thanks to the patronage network between the business elite, politicians and senior civil servants. Indeed, the AFC capital controls and ringgit peg are decisions made to, primarily, protect these elites.

Don’t just treat the symptoms — address the underlying cause!

Right at the top of the food chain are the private sector monopolies and oligopolies, state-owned and government-linked companies (GLCs) that extract economic rent — profits in excess of production costs, above and beyond the normal profits in a competitive marketplace. The protectionist policies limited domestic competition and deterred investments, including in crucial R&D. We have no doubt that state capture has stifled innovation and entrepreneurship, and all the possible productivity gains. And they do not reinvest (what is there to invest if your main asset is licensing?) but remit their profits abroad.

Over time, this rent-seeking culture became rampant throughout the economy. Corruption is now systemic. Businesses are forced to pay to “grease the wheel”, raising the cost of doing business, especially significant for the micro, small and medium enterprises (MSMEs). Wages are low because companies cannot afford to pay more.

Rising cost of doing business (due to economic rent) = lower profits (ROE) = lower wages

At the same time, inefficiencies are imposed down the supply chains, resulting in higher prices — and cost of living — for the people.

So, if Malaysia is to continue rolling back on broad subsidies (in favour of subsidies targeted at the low-income households), please also remove the monopolies and oligopolies, and all sorts of licensing. Allow free market competition to ensure the lowest possible prices for everyone, especially the “squeezed middle” because they will pay the “highest relative costs” as subsidies are removed and become targeted.

We are not questioning the need to “force” or motivate companies to invest in R&D, to innovate, to adopt better production processes and advanced technologies (including automation and robotics) in their businesses — to move up the value chain and increase the domestic value-added.

But we also need to understand the structure of our economy, and why we are where we are today. Forcing wages higher (increasing costs) without a corresponding rise in productivity gains will lead to loss of competitiveness and an even faster profit decline for businesses — and eventually widespread layoffs. Many might well end in failures and closures or businesses will simply relocate to other countries. Investments will decline and unemployment will rise.

Businesses invest and innovate only when they are profitable, or when they are forced to by market competition. In previous articles (published on July 24 and 31 and Aug 7, 2023), we described how South Korea successfully raised the country’s productivity and income levels — by opening up its domestic market to investments and competition, thereby forcing companies to innovate and move up the value chain. Essentially, compete or die.

What about the impact of higher private sector wages on the public sector? Surely civil servants will also demand higher wages. What will this do to already-high public deficit and debt levels? What if higher wages without corresponding gains in productivity trigger a wage-price spiral and runaway inflation, which not only nullify the wage in creases but also collapse the ringgit, stock market and wealth?

We are not predicting doom. We are saying we do not know. The consequences are highly unpredictable and risky. Most of all, we are saying, treat the underlying cause, not just the symptoms.

We believe the job market is largely efficient. Workers are mobile. Firms must compete for talent and they will pay to attract and retain workers — if they can afford to. Case in point: Only recently, audit firms have been forced to raise the starting salaries of new recruits from RM2,800 a month to over RM4,000 a month — driven purely by market forces, not government intervention. On the other hand, the consequences of direct wage intervention policies — fixing the “right” numbers by itself will be an extremely difficult and complex task with in complete data — could be disastrous for the nation. Let’s make sure the “cure” for low wages does not end up being more painful than the “symptoms”.

The Malaysian Portfolio was unchanged last week, and the benchmark FBM KLCI fell 0.8%. Total portfolio returns now stand at 158.2% since inception. This portfolio is outperforming the benchmark FBM KLCI, which is down 21.3%, by a long, long way.

For readers who may not fully comprehend our past article titled “Targeting 45% labour share of total income for Malaysia is imprudent and without basis” (published on Aug 28, 2023), the key takeaways are (1) that such a target is not meaningful and setting a wrong objective can lead to bad decisions (wage share of income is a function of the structure of the economy, just like wage share of a company), and (2) the appropriate targets are GNI per capita in US dollar and the Gini coefficient, which measure the average income for the nation and equality of income respectively.

Box Article 1: What about the T60 minus T1 (T60-1) of the population?

Hardly a week goes by without someone or some media report lamenting the plight of the B40 — whether it be low wages, abysmal savings, unaffordable housing or schooling or transport, high cost of living, of eating out or indeed eating at home.

The idea is that they need help, targeted assistance and subsidies — from petrol to rice to sugar and cooking oil — cash handouts, grants for education and loans to buy homes. These grow louder during election times — a sizeable voter bank where cash is king.

No one begrudges the help extended to those in need. Society benefits from improving the well-being of all.

The question is what about the T60-1? They are comparatively better off. They are never mentioned by politicians and the media. They do not have special access, handouts, grants and so forth. In fact, they are almost always left to their own devices — independent, to do what they must for survival, for advancement. They save what they can, provide liquidity to the banking system so that loans can be extended to large corporates and poor households. They are the biggest group of individual taxpayers.

So, what do they get in return — as good hardworking citizens, paying taxes and contributing to economic prosperity for all? They only want ease of doing business, less corruption, less bullying, less discrimination in their business and licensing as well as in their children’s education, lower cost of living, less depreciation of the ringgit, a better stock market performance and less inflation.

The T1 are already “over-entitled”. They own the licences, they are rent seekers, they extract the nation’s natural resources and control the levers of power — hence the T60-1.

Should what little benefits that currently accrue to the T60-1 also be taken away so that more of the national coffers can be directed to the B40? A popular and almost nationally accepted consensus is targeted subsidy — especially for petrol. The danger of “crowd thinking or herding” is that it leads to dependency and inability to think critically.

Petroleum (oil and gas) is a national resource belonging to all Malaysians. Because we are a net producer, the decision in the past was that all Malaysians should benefit from it — by paying less. Now, we are told that the T60-1 should not be entitled. That this is “wasted resources” on them. Instead, cut this off so that money can be saved in the government budget. For what? To give more to the B40 (who will be entitled to this targeted subsidy) — they need even more help? (Of course, they do. Who will ever have enough?) — or to let the government spend on other projects?

The fact is that higher oil prices will lead to higher revenue for the government. But the headline story is, repeatedly, that higher oil prices lead to larger subsidies that is bad for the country. This is simply NOT true. It is a narrative to divert away what little benefits currently enjoyed by the T60-1.

 The accompanying Chart shows the clear positive correlation between global oil prices (grey line) and the government’s petroleum-related income less subsidies (yellow line). Higher oil prices translate into higher net government income, after deducting the higher subsidies.

Furthermore, targeted petrol subsidies — resulting in higher retail prices for petrol — will, without a doubt, lead to yet another round of inflationary effect across the board. That is, even higher prices for food, goods and services. And higher inflation will lead to either higher nominal interest rates or a weaker ringgit. In other words, this will hurt all, but the T60-1 will be hurt the most.

We understand that the nation has limited fiscal space and there is the need to provide assistance to the B40, whether subsidies, handouts, wage subsidy and so on. But why is it that the T60-1 always has to pay? Taking away their petrol subsidy is an indirect tax on them — and more money for the government. The key to improving the well-being of all Malaysians is to grow the pie — not in “robbing Peter to pay Paul”.

Do not keep weakening the middle class. Economic prosperity (with capitalism) and political stability (under democratic regimes) are possible only with a deep and wide middle class. 

— Box Article 1 Ends —

Box Article 2: How Singapore plans to improve the well-being of the broad middle class while lifting the lower-income

Speaking at the Economic Society of Singapore Annual Dinner last week, Deputy Prime Minister Lawrence Wong outlined the city state’s plan to address inequality (as reflected in the Gini coefficient) and social mobility. Here are some key points:

To advance the well-being of the broad middle-income 

• Build on competitive strengths to attract quality investments and scale-up homegrown enterprises to help people secure better-paying jobs (improve real incomes and living standards), notably in high-value and productive firms. In other words, upward income mobility;
• Economic restructuring and allow the forces of creative destruction to work through the economy, not prop up non-viable activities with low productivity;
• Further improve total factor productivity (TFP), which has grown 0.4% a year from 2012 to 2022; and
• Step up investments in adult education, training and retraining for laid-off workers in the economic transition with tech advancements.

Lift the lower-income segment

• To reduce the occupational wage gap between “hands” and “heart” work (technicians and service workers) and “head” work (managers and professionals) by upgrading the former group’s skills over time; and
• Redesign jobs, raise productivity and build better progression pathways industry by industry.

To ensure absolute mobility in society, so that everyone keeps moving up

Singapore’s plans for the next phase of nation-building dovetail with many of the key issues — and solutions — we have raised in our recent articles. To improve the well-being for all Malaysians, we must grow the pie — everyone keeps moving up. And the best way to achieve this is to ensure equality of opportunity (read our previous article “End state capture, to enable economic transformation and improve livelihoods” in The Edge dated Aug 7, 2023) instead of focusing on equality of outcome.

As we wrote in the main article this week, the key to raising wages is in upward wage mobility, by creating higher paying jobs through investments and improving skills and productivity — not by the government subsidising private sector wages. Achieving this requires careful planning and, critically, execution. And, yes, the results will only be evident over time. Like an athlete, however, long-term, sustainable improvement in performance comes from hard work and training, not in taking “steroids” (wage subsidies) that may well be career-ending (disastrous for the economy).

We need to advance the well-being of the middle class, and not continuously raise their cost of living — for instance, in removing what little subsidies (for petrol, for example) they have left — and redirect savings to the B40. And the measure of inequality is the Gini coefficient, not a meaningless labour share of GDP (which, as we explained, simply reflects the structure of the economy)

— Box Article 2 Ends —

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