How the labour laws hold back job creation

At the Business Unity SA economic indaba, the president spoke about his commitment to growing the economy and the need for more jobs. In this context, he said he did not understand what problems business had with existing labour legislation and that he had not been presented with a cogent argument from business about what ought to change and why.

If this is true, and business has not, in fact, spoken to the president about the relationship between existing labour market rules and our horrendous unemployment statistics, one would have to conclude that the leaders of organised business are either not listening to their members or are failing in their duty to articulate their concerns.

The Centre for Development and Enterprise (CDE) has released a new report on SA’s jobs crisis in which the relationship between our labour laws and unemployment is extensively explored.

It concludes that the main cause of joblessness is that economic growth since the 1970s has been too slow to absorb new entrants into the labour market, but that our labour laws have, in fact, played a considerable role too. SA’s labour laws increase the risks and costs of hiring workers, and this effect is disproportionately strong for young, unskilled workers.

Three areas of policy have pushed employers to employ fewer unskilled workers: industrial policies, the system for setting wages, and the imposition of a variety of non-wage costs on employment. SA’s industrial policy is biased against employers of unskilled labour, and has been so for decades. The most egregious manifestation of this bias is the huge direct subsidies received by the vehicle manufacturing industry (which is capital-intensive). These subsidies do not result in lower vehicle costs, because the industry also enjoys enormous protection against imported vehicles.

Reinforcing the biases of industrial and energy policy, our labour law has discouraged the employment of unskilled workers. It has done this to improve the working conditions and living standards of workers in the formal sector, but the result is that employers can afford to create only jobs that generate a higher level of output. The result is that fewer jobs are created.

Legislative constraints on dismissing workers, for example, have expanded job security for those who are employed, but they have increased the costs and complexity of the relationship between employers and employees. Even where concessions exist — such as the somewhat wider latitude employers have to dismiss unsuitable workers while on probation — the rules are onerous and have been drafted on the presumption that employers will act in bad faith if given half a chance.

Policies of this sort increase employers’ reluctance to employ people, and the effect is felt most strongly among young, inexperienced, low-skill work-seekers. An employer is generally willing to incur more costs for a skilled worker who might make a substantial contribution to the firm’s bottom line than for an unskilled worker. These non-wage costs are important, but it is the level of wages paid to unskilled workers and, critically, the pace at which these have risen, that is the key factor in reducing job creation.

The rise in wages is driven by deliberate policy interventions such as the national minimum wage, ministerial directives that have imposed minimum wages in sectors in which workers are deemed to be vulnerable, and the institutionalisation of a centralised wage-setting system, a core feature of which is the strengthening of organised workers’ bargaining position.

These policies improve employed workers’ lives, but a price is paid in slower job-creation, especially for unskilled workers. Do the benefits exceed the costs? In support of these policies, two arguments are made. The first is that raising wages is growth-enhancing because it shifts demand towards lower-income households that save less of their income and whose consumption is skewed to local goods and services. The result is an increase in aggregate demand, which facilitates growth.

This argument is deeply flawed. One reason for saying so is that it could be true only if, higher local wages did not translate into higher prices that would serve to reduce consumption. This is unlikely to be the case. Nor is it clear that poor people devote a larger share of their budgets to local goods and services, since imported food (chickens), transport costs (petrol) and cellphones account for a significant fraction of their household spending. Higher prices would also mean local goods are less competitive on global markets, reducing exports, which would also slow growth.

Apart from this, the logic of the model implied by proponents of wage-led growth is that growth is accelerated by shifting purchasing power from those who might save (the rich) to those who would spend (the poor). 

The problem with this is that an increase in the overall rate of consumption means, by definition, that the savings rate must fall. This is not a good thing: SA already runs a current account deficit, so any decrease in savings must, as a matter of mathematical certainty, be accompanied by either a reduction in investment (to match the decline in savings) or by a widening of the current account deficit as the flip side of the inflow of foreign capital.

Thus any move to increase consumption that is not accompanied by a decrease in investment (which is obviously undesirable) implies an increase in imports rather than an increase in local production.

Higher wages, in other words, simply cannot accelerate economic growth. A more plausible justification for policies that push up workers’ wages is that they reduce poverty and inequality. Here, the core claim is that higher wages reduce poverty by raising household income. But this would be true only if the positive effect on poverty and inequality of higher wages on household income among the poor is not offset by any negative effects.

If higher wages lead to higher prices and/or slower job creation — or, worse, to job destruction — there is no guarantee they will translate to lower levels of poverty and inequality overall, even if they do reduce poverty in the households in which wage-earners enjoy higher incomes.

The effect of higher wages on poverty and inequality is to make recipients better off and reduce the gap between their wages and those of people who earn more than them, but potentially this leaves more people unemployed. Ambiguous outcomes exist for all policies, but in a country with more than 10-million unemployed, an approach to development that supports the fastest possible expansion of employment for unskilled workers, even if that is at low wages, should be the preferred option.

Ensuring existing workers’ living standards are not sacrificed to achieve employment growth must be an important policy goal, but so too must be the expansion of employment for those who will otherwise be left behind. High levels of unemployment impose monetary and social costs on others, and on the communities in which the unemployed live, while employment helps make possible the accumulation of capabilities, skills, dignity and independence that cannot be acquired through other means.

There are convincing arguments about how existing labour laws have helped deepen our crisis of joblessness. If business has not conveyed this argument to the president yet, one hopes someone will soon.

• Bernstein is CDE head. This article is based on a CDE report: Ten Million and Rising: What it would take to address SA’s jobs bloodbath.