Raising productivity through wage rises

Raising productivity through wage rises

SINGAPORE - Do increases in labour productivity lead to wage increments, or is it the other way around?

Improving productivity, particularly labour productivity, is a major focus of Budget 2013. The rationale behind this is that an ever increasing living standard is only sustainable if labour productivity keeps increasing.

Labour productivity is measured by the value-added per worker. This reflects the effectiveness and efficiency of labour in the production and sale of output. So, if a chef cooks a $200 meal in an hour and the ingredients of the meal cost $50, the labour productivity, or value-added, of the chef would be $150 per hour.

Although we call it labour productivity, it is actually attributable to both the chef's service and the physical capital used in making the meal, such as kitchen equipment and rooms to host customers. Clearly, an employer will not pay the chef more than $150 per hour for his services.

In a perfectly competitive labour market, wages are equal to labour's contribution to the value-added, which is proportional to labour productivity. Increases in labour productivity will always lead to wage rises.

However, wages and labour productivity do not always move together. The relative bargaining power between employees and employers determines the gap - or the wedge - between wage and productivity, which has varied considerably. In the US, Dr Lawrence Mishel of the Economic Policy Institute found that the wedge has increased only gradually over time due to a slower rise in wage rates. Between 1973 and 2011, labour productivity increased at an annualised rate of 1.56 per cent while the average hourly wages increased by only 0.87 per cent.

The disconnect between productivity gains and real wage increments has also been observed in many other countries. For instance, while the real wage in Germany and Japan remained flat between 2000 and 2008, productivity had increased by 10 per cent over the same period.

A large gap between wages and productivity is not necessarily always bad news for workers.

First, a larger gap implies higher profits, which provides a stronger incentive for investors to create jobs. As the employment outlook improves, workers' bargaining power increases and so do their wages. Secondly, it provides room for wage growth when productivity grows at a lower rate.

The latter explains why in Singapore, wages increased by 2.3 per cent between 2011 and last year although labour productivity actually fell by 2.6 per cent over the same period. Clearly, wage growth cannot outpace productivity growth forever. Once the wedge narrows to a certain extent, any further increase in wages without productivity increases will hurt employment. Sustained wage growth must be accompanied by productivity growth.

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