Minimum wages and SME

From Sensus Ekonomi 2006 (quoted from a seminar presentation):

The data supports the sentiments such as "SMEs are important to our economy as they create most of the employment" kind of thing. I agree. Now look at the average wages they paid to the workers. Here is the question: if we keep increasing the minimum wages, and enforce it, who are to win and who are to lose?

Wages, unemployment and formal employment

Take a look at these charts:
Here's how I read them. First, (A) and (B) show a strong association between real minimum wages and overall (average) employee wages. The relation was most obvious between 1999-2003. This shows that minimum wage has become an arena of collective bargaining. Wage negotiation happens not in the private sphere (within company) but in the public sphere (policy). This indicates an institutional failure in the labor market: bipartite negotiation. Since 2003, real minimum wage has been relatively stagnant, so has the overall wages.

Second, (B) and (C) can be divided into three periods. Prior to the crisis (1998), all went well in the sense that wage was growing, and so was formal sector employment. From 1999-2003, when wages was increasing rapidly, share formal sector employment declined significantly. After 2003, wages has been relatively stagnant. It is no coincidence that formal sector employment started to expand.

Note: 1) you won't see the relations as significant if you just simply take one point of time and compare it to another (say, 1999 vs. 2008). 2) a colleague of mine did an econometric estimation and confirmed that every 10% increase in average regional minimum wages is associated with 1 percentage point decline in the share of formal sector employment a year later.

Third, I didn't put it on the picture -- but apparently there is an obvious relations between wages and unemployment. Our friend Suahasil Nazara and his co-author Iyanatul Islam might be right (like Card and Krueger). But I second Prof. Aris Ananta that unemployment rate may not be the best labor market indicator, as it doesn't tell much about job quality and welfare. In such case, formal sector employment should be a better indicator.

Now the question is who wins and who loses if the minimum wage is increased?

Six and Eleven Thousands

One of our cafe regulars, Patris, once told me that in an FGD on public services reform she organized, those so-called experts refused to elaborate her question on the ratio of public officer to the economy (like GDP, or population, or size), in comparison to other countries --or so, I was told.

They deemed the ratio, those numbers, as irrelevant, because it all depends on, well.., something else. Of course, numbers might not give you complete answers, the wrong numbers can be disastrous too. But it does have some useful information.

Consider this:
a. The Ministry of Finance has surplus of incompetent officers but at the same time lacks of badly needed officers, such as tax inspectors.
b. The Ministry of Finance has surplus of six thousands incompetent officers but at the same time lacks of eleven thousands more badly-needed officers, such as tax inspectors.

Which one is more useful information? Alas, even the so called experts are too lazy reluctant to come up with figures, and often goes with type a explanation.

The first step to public reform, of course, to know how many people we need to hire --and scrap out--, given the needs in hand.

Footballnomics #9: are foreigners to blame for England's failure?

Not surprisingly, England failed to qualify for Euro 2008. They should just simply accept that they are not good enough. Blaming the failure on the huge influx of foreign stars is clearly out of the line. Neither will imposing a cap on the number of non-English players will help. I agree with Arsene Wenger in this case.

For one, the English team have never been great. Before the EU single market that revolutionized the football transfer market in the early 1990s, when there were only three foreign players allowed to play, England never won anything except the 1966 World Cup (the only trophy they have ever won). So the number of foreign players in the English League can not explain the national team's performance.

And remember, the EU open labor market also applied to the other countries. Foreign players have been coming en masse to France, Germany or Italy. Yet these countries won the 1998, 2002 and 2006 World Cup respectively (Germany also won the European Cup in 1996, and France in 2000).

Some people argued that foreign players have limited the chance of English players to play or be recruited by top teams. That is simply because English players are too expensive, given their (average) quality. To judge the quality of English players, just look at how many Englishmen play in the continent at the top leagues. Currently, none. At its peak, four (Owen, Beckham and Woodgate in Madrid, Hargreaves in Bayern Muenchen; altogether, only them plus Gascoigne and Ince in the 1990s who have ever played abroad).

Italy can have a stronger team because their best players can still outcompete foreigners in Serie A. The French League, on the other hand, is less competitive than the EPL, Serie A or La Liga. There are a lot of foreigners, mainly from Africa, in the French League. But the best of French players are good enough to be the best players in England, Italy or Spain.

In short, the Englishmen can not blame globalization for their crappy performance. Globalization brings competition. It exposes the country's weaknesses that come out because of domestic problems.

Update: I forgot to mention David Platt and Steve McManaman as the other English players who have played in the top European Leagues in the 1990s. Also, Kevin Keegan did it in the early 1980s.

Footballnomics #6: Fabio Capello

We've already seen some turnovers in the manager jobs. But nothing is more dramatic (this year, at least) as the sacking of Real Madrid's Fabio Capello. To be honest, I don't really know whether it was the club who sacked him, or was it Capello himself who wants to quit, or was it a mutual agreement between the two. Newspaper reports suggest that it was the club that took the decision (like this one, which used the word 'axed' in its title). Furthermore, the decision was taken while Capello was on vacation in Tibet, so no words from him are available yet.

Capello's departure seems to be a strange decision, given the fact that he brought the La Liga title in his first year (well, his first year of the second term at Madrid). But then, just like players, the manager job market is not like a standard labor market. So we need more than the standard labor economic analysis to understand what happens.

As Leo Tolstoy once said, "All happy families are alike. All unhappy families are unhappy in their on ways." All happy, job-secured managers have these conditions met: have a good relationship with the club, players and supporters, and is able to achieve the expectations of the club's stakeholders given the budget. With the exception of Jose Mourinho, Lose one of these conditions, and most likely you are heading somewhere.

That, perhaps, what happened to Capello. In the basic principal-agent setting, a manager is an agent acting on behalf the principal, who has some certain objectives. One may think that bringing the league title means that the objective is met. True, if it is the (only) objective. Looks like Madrid's board of directors has a greater set of objectives in their mind, which Capello could not deliver:

• A Champions League title
• Higher revenue (losing Beckham means losing a big source of revenue)
• A certain type of 'style' in playing football
• The directors' health. The board may be forward looking. If every year the title has to be won in the very last minutes, it would be bad for their heart condition, and the club's financial position if they have to pay the medical benefit. After calculating this potential expenses, even after considering the club's obligation to pay Capelllo's GBP 4m annual salary for the remaning 2 years of his contract, it is still beneficial for the club to terminate the deal.

However, having sacked seven coaches in four years (including Capello's first term), one should wonder what the principal's objectives are, if any.

Footballnomics #5: transfer market

The English and most other European top leagues are going into summer hiatus. Now the activities and attentions switch off the field: transfer market. No World Cup or European Cup for clubs to do their window shopping, so most player buys will be based on mostly last season performance.

Football transfer market has been subject to many criticism for the past few years because of the inflated players' value and wages. The late Pope John Paul II once raised his concern that a football player can earn up to GBP100,000 per week, while millions of people in the world are still living below the poverty line. Forgive them, Father, for whatever sin they have committed.

Apart from that, explaining (or modeling) the transfer market is indeed a challenging task. What makes a club willing to pay GBP20m or more for a player (and pay him another 100k a week)? The player market is different from the regular labor market. It does not deal with labor with homogenous characteristics. It is rather a monopolistic competition market because each player have a monopoly over his skills that distinguish him from other players, which are observable by clubs. In the standard labor market, each workers have different skill. But firms can not observe each individuals, so they look at the pool of similar workers, and the market wage is the average earning of an average worker. Consequently, we cannot exactly draw the market demand/supply curve for player. (Therefore, it is more relevant to compare player market with the market for executive or other professionals).

So, again, what determines a player's transfer price and wage? The first and foremost is, of course, skill. This is very observable. A striker is judged by his goal tally; a midfielder by assists or passes completed; a defender by tackles; a goalkeeper by number of clean sheets or saves. Number of caps can also be another measure. There are also subjective measures like 'work rate' or 'contribution to team's success.'

A second factor is how far does a player have before his contract expires.* Obviously, when a player is closer to the end of his contract, the options for the club is either sell him in discounted price, or receiving nothing when the player decides not to extend his contract and becoming a free agent.**

If you think of a wage regression model, you may want to add a third thing: dummy variable for British player. For no obvious reasons, British players tend to be overvalued. Aston Villa just paid GBP7m for West Ham's Nigel Reo-Cooker, and Newcastle paid GBP5.5m for Man City's Joey Barton, and they don't even make it to the senior national team. The price of British youngsters are also inflated. That explains why most managers prefer to look for youngsters from the continent. And the English FA officials are complaining that the national team is suffering from the under-representativeness of English players in the top teams?

Some purchases are speculative. For example, youngsters are valued by their 'potentials for success' although they are yet to have established record. Players like Wayne Rooney may, up to know, justified their values. But no one knows why in the hell that Arsene Wenger was willing to pay GBP12m for Theo Walcott. (To be fair to Mr. Wenger, his buying record was excellent. But he made some blunders like Francis Jeffers a few years ago). Some players are skillful but injury prone. Newcastle paid GBP15m for Michael Owen who spent most of last season on the treatment table. Success in a country's league does not mean a replication in the other country's (Andriy Shevchenko, GBP30m from AC Milan to Chelsea). Some players are skillful but have off the field antics. And so on.

And some players are bought for partly non-footballing reasons. Think about the Asian players in the European leagues. Why do you think the reason Real Madrid bought David Beckham? And the motive behind Beckham's move from Los Galacticos to L.A. Galaxy?

Then, we can not ignore the role of agents in determining players' moves, transfer prices and salaries. Not that agents are bad. They do reduce searching costs, so players and managers can concentrate in training while their agents do the dirty work. Nevertheless, agents are also allegedly contributing to the players' inflated prices, although they do it legally. Well, some don't do it legally, like the recent allegation of transfer 'bung' involving Wimbledon FC.

Speaking about agents, I recently had a chat with an Indonesian sport journalist. According to him, transfer bung are very common in the Indonesian league. Here how it works. An agent offers the manager a deal to purchase a player he represents, and promised to share the transaction fee (or part of the player's monthly salary). It's the standard principal-agent problem since it's the club money, not the manager's. That's why we see a lot of foreign players with almost zero quality in the league (one player was a plumber in his home country).

Note:
* According to the Bosman rule, 6 months before his contract expires, the player can sign a pre-contract with the new club. That's why when clubs want to keep their star players, they must negotiate a new contract when the players are as far as 2 years away from the end of their contracts. If the negotiation collapse, the club at least will be able to sell the player at the beginning of his final season.
** If the club gets a player for free, that means the club has more money to increase the salary. Hence, we see many 'free' players have higher salary level.

When excess supply is a win-win

This is hillarious. According to The Jakarta Post here,

Minimum wage rise [is] a compromise of supply, demand

Let's see:

1. Policy is supposed to be effective, agree? (Otherwise, what's the point of making a policy?)
2. Now, for a minimum wage policy. What is 'effective'? Effective minimum wage is when wage can not go lower than that, agree?
3. What is 'compromise' between supply and demand? It is a situation where supply meets the demand (or demand meets the supply, whatever), no? Economists call it 'equilibrium'.
4. Now, if supply and demand meet, is there any excess? No. Because if there is, it is not an equilibrium. Not a 'compromise'.
5. So, in order to be effective, a minimum wage should be higher than equilibrium wage. That means, it should be such that an excess supply is in effect.
6. In other words, the title of the news is at best, misleading.
   

More coffee, please?

Econ Fallacy

Econ301: Education and labor market signaling

Note: while Aco continues the Econ 101 series, allow me to squeeze in with some more advanced topics. Usually, in our university, the better teachers are assigned in introductory courses. In our cafe, the manager assigned Aco, our best barrister, to serve the younger, funkier customers...

Updated note: a version of this entry was published in The Jakarta Post (15/8/06).

Why do many people hopes to get higher education, university degree in this case?

The most common answer is because having a university degree makes it easier to find job. Actually, this is not the correct answer. Several researches have shown that people with high school diploma or lower have greater chance to be employed or to switch jobs. Especially after the economic crisis, people with higher education are more likely to be employed. The correct answer is: to get a better-paid job. True, university diploma does not make it easier to get job. But certainly it enables one to have higher salary.

Why then higher education gives higher earning? The answer seems to be obvious. Education provides workers extra skill, which enables them to be more productive. Since workers are rewarded in the labor market based on their productivity, it is the higher productivity which brings them higher earning. Hence, the higher one’s educational attainment, the higher his or her wage. This is the Beckerian answer to the problem.

But such view was not too convincing. Labor market, like any other market, is not perfect. Employers can not evaluate the true productivity of potential workers before he or she starts working. But we know that typical job application process, the wage rate is agreed in advance.

So, on what basis will wage rate be determined?

According to Stanford University's Michael Spence, in the world of asymmetric information, employers only assume higher educated workers are more productive. Not that a college graduate in is actually more productive; it is what the employers believe to be. So, to distinguish oneself in a stack of application, a job searcher shows his/her university diploma to signal the prospective employer that he/she is a productive type. In other words, higher wage is a reward for the diploma one gets, not a worker’s true productivity.

He wrote his seminal article in 1973 [1] - and his model was then called "the signaling model." Spence won the 2001 Nobel Prize in economics, together with George Akerloff and Joseph Stiglitz.

What does the model imply?

The signaling model changed the way people looked at how labor market works. The fact that signaling mechanism partly, or mostly, determines the market wage setting has an important implication. University degree helps increasing wage as long as those with university diploma accounts for only a small fraction in the labor market. When the share of university graduate grows, it will no longer be an effective signal. Employers will look for new type of signals to distinguish workers, such as more advance degrees (Master’s, Ph.D.), professional degrees (CPA, CFA), or graduating from 'top' universities (err... UI?).

When the government subsidizes university tuition fees, it makes higher education cheaper and more accessible. It will increase the supply of college educated workers. However, it may not be useful because employers will increase their expectations subsequently. For that reason, subsidizing university tuition does not make a good social investment. It may even have an adverse effect: a large pool of highly educated unemployment.

[1] Spence, A.M.: "Job Market Signaling", Quarterly Journal of Economics Vol. 87, No. 3 (1973), pp. 355-374.

Education | Labor market | Signaling

If Looks Could Kill

Why does a country restrict the presence of foreign workers in its domestic labor market? Usually the reason would fall into one or two of these categories:

a. driving down the domestic wage (the case of US immigration law debate, not so long ago)
b. local customer protection against low services provided by foreigners
c. cream-skimming and creating inequity
d. crowding out the domestic worker's employment.

Okay, you may say, in the end, it is all about fear of competition.

But after reading a short article in The Jakarta Post 13/07/06 (alas, no link) on Malaysia's recent policy to lift the ban on Bangladeshi workers, you may want to add up one more reason. But let me quote part of the article first:

Malaysia restricted the number of Bangladeshi workers in the country in 1996 and banned them entirely two years ago, after it said they were creating social problems by entering into romantic liasions with local women.

Officials have said the Bangladeshis, who looked like Indian movie stars to some local women, had seduced and eloped with them.

Yes, it is love and good looks that prevent a country from gaining profit from international trade in services.

For me, it doesn't sound right for two things: First of all, it undermines fair competition both in labor market and, more importantly, love market. Second, it implies that foreign workers with good looks actually don't have as big an opportunity as those who are less fortunate in that area.

Talk about male chauvinist pigs. Come off it. Let the competition go on

Addendum:
A self-reflection on our profession, for university teacher, does looks matter? Yes, it does for having higher instructional rating, as Hamermesh and Parker (in pdf) say (via Greg Mankiw's blog), particularly, alas, for male teacher. Yet whether it reflects productivity gap or discrimination is probably impossible to judge. Gosh, somehow I feel relieved by this caveat.

p/s: From that paper, I like a punchline from supermodel Linda Evangelista: It was God who made me so beautiful. If I weren't, then I'd be a teacher. Yes, yes, we call it division of labour. It'd be more efficient this way.

economics of beauty | labor

How more, not less, globalization can be beneficial for low skilled workers

In Indonesia as in many parts in the world, May Day was celebrated by or with the support of the anti-globalization movement. In the US, more than about any other issues, the last May Day is almost exclusively about the issue of immigration. Sylvia Tiwon at Indoprogess saw what happened earlier this week in the streets of major US cities as evidence of "the irony of globalization" and she argues that "it is time for the laborers in the US...to recognize that poverty is an integral part of globalization".

I agree with the first statement that there is indeed this irony: on one hand the US government is trying to curb the flow of undocumented immigrants, while on the other hand, US businesses and households are taking advantage of these (illegal) immigrants. But I can't disagree more with her second statement - the globalization-poverty nexus. If anything, loosening immigration, thereby implying more globalization in the form of increasing labor mobility may be the fastest way to equalize the wages for unskilled workers between Mexico and the US. By doing so, it also has the enormous potential to help reduce poverty south of the border. I am more sympathetic with Rizal's view:

"...if what we mean by globalization is a free mobility of factor of production, how can we simply put aside the labor movement --itself a very significant, if not the most crucial, factors of production beside capital and goods?"

Like Rizal, I also tend to believe that more globalization, not less, in the form of high mobility of labor can be beneficial for the low-skilled workers from poor countries.

To drive this point further, an article by Stephan Faris at Salon is worth discussing. While he was living in Nairobi as a journalist for Time, he employed in his household the following: a nanny, a maid, a gardener, and a watchman, all for a combined daily wages less than the cost of the main course when he went out for dinner. All that was possible because he "drew Western salary and paid African wages" (a situation many expats in Indonesia may have no problem relating to). But he is smart enough to leave his troubled conscience behind and wrote:

"...Those who squirm at the idea of having servants should consider that there's little moral difference between me and my maid, and those who buy a washing machine whose low cost depends on other people's deflated wages. We've globalized capital, but not labor. A washing machine manufacturer can cash in on China's low wages, but the Chinese factory worker is barred from taking a boat to seek better pay. He's forced to sell his labor at much lower than the global market value. Both my maid and the factory worker would prefer to work for Western wages. But they can't because of immigration restrictions..."

Indeed. The main reason why people emigrate to other countries is to take advantage of the differences in potential earnings (Massive Movement of Refugees and IDPs and Chronic and Sustained Human Flight notwithstanding). Why wage discrepancies for the same skill level exist and why they persist are obviously determined by various things (e.g. endowment, technology, institution etc., see this for a simple yet powerful exposition). But perhaps one of the most important things that prevent these discrepancies to disappear is the set of immigration restrictions. Even with restrictions in place, the potential emigrants may internalize the cost and still view that the wage discrepancies are still worth taking the risks for.

Sounding like an economist, Faris then argues that:

"...From the standpoint of economic theory, liberalizing the flow of labor is no different from liberalizing trade. Both redistribute a nation's wealth, with a net positive effect. The difference is that liberalizing trade disproportionately benefits richer countries, while easing immigration restrictions would help the world's poor..."*)

Moreover, in most if not all countries, immigration restrictions disproportionally hold back the movement of low-skilled labors. A PhD in molecular science would be in better position to come to the US than a high school graduate (it is tempting to talk about brain drain and some misconceptions about it at this point but let's not). On the other hand, or rather because of it, the potential gains for unskilled workers are likely to be greater because the factor market for these unskilled workers is not as integrated as the one for highly-skilled labors. By loosening the immigration restrictions for low-skilled workers the dreams of better lives for them may be realized sooner. Even if it means that we need more globalization.

*) Some may be put off by any statement that begins with "From the standpoint of economic theory". But even the accidental darling of anti-globalization movement, Joseph Stiglitz, has the following message buried in his powerpoint file (see page 45) about the state of development in Latin America:

" The successful countries have actually followed models which are more in accord with economic theory than the Washington consensus "
(Hat tip to Martin for the link to the file)

Addendum:
Tyler Cowen of the Marginal Revolution fame and DanielRothschild wrote an op-ed in LA Times (via, what else, Marginal Revolution), addressing the same debate. Here's a quote:

"A key question for economists has been whether the influx raises or lowers"native" American wages. UC Berkeley's David Card, who studied patterns in different U.S. cities, concludes that immigration has not lowered wages for American workers. George Borjas of Harvard counters that immigration reduced the wages of high school dropouts by 7.4% between 1980 and 2000.

Most economists have sided with Card."

In the op-ed, Cowen and Rothschild also label Borjas as "the favorite economist of immigration restrictionists", an assertion I suspect many economists would also not find difficulties to side with.

Globalization labor

Who wants labor market inflexibility?

I was invited by friends from Akatiga and Sociology Lab, FISIP-UI to discuss their research on Labor Market and Investment Climate. It was a good discussion.

In their sociological research, they particulary concern that labor market flexibility would degrade the labor condition and job security --and argue that due this flexibility there's a shift of permanent employment to non-permanent one (outsourcing, contract, etc) so that the labor's wealth and income becomes less certain.

My take: it is the labor market IN-flexibility that causes all of those problems abovementioned. In fact, so far our labor market is not yet flexible. The inflexibility imposes high cost for firms to hire permanent workers --and to fire when necessary(the severance payment is as high as 10 months salary, according to a fellow discussant from CSIS)--. Therefore the firms opt to hire non-permanent workers.

It seems to me that they're alarmed by the current formal worker's job security status, but as you may know the labor market rigidity harms the ones who are outside the formal sector --the unemployed and the informal sector's worker. It is a trade-off indeed between employment creation and job security of the labors already within formal sector.

Moreover, another discussant from SMERU revealed a bad news: he estimates that 1% economic growth may only absorb 225K employment --way below the government's figure. And according to our CSIS fellow, there is a recent shift from labor intensive to capital intensive investment --to partly confirm the low employment absorption.




Labor Market

Down with the minimum wage

In one seminar yesterday, a participant called for higher minimum wage for labors. He asked why is it so difficult for the government to raise the minimum wage? The question was not addressed to me directly. But I would have responded like this:

My mother hire two maids. In Jakarta, it's normal to pay 700 to 800 thousand rupiahs to a maid each month. Say it's 800,000. Now imagine that the government require households to comply with the minimum wage law. For Jakarta, it's Rp 1 million. What would my mother do? Well, she might give up one maid, and hire only one. Or, if she ever thought to hire a third one, she would cancell that. In the first case, my mother would send one person to unemployment. In the second case, my mother could have created one employment, but thanks to the minimum wage law, she called it a no.

What's the moral here? Minimum wage law is good only for those already in the job and who are lucky not to get kicked out by the saving employer. Minimum wage law is bad for unemployment.

You might ask: but minimum wage law is not required for households. What difference is there between companies and my mother?

Education creates employment, or the other way round?

Just got my proposal for Second Year Policy Analysis being reviewed and, well, criticized by my supervisor. I plan to do some analysis regarding Female Labor Force Participation. One thing he mentioned: education is not endowment. It is a choice variable. It's not "education that creates employment". Instead, it is the (chance of getting) employment that creates the incentive to go for education.

On a different case, but pretty similar, this guy just decided to quit Harvard because the marginal return of another year at Cambridge, MA 02138 is very small (even negative?).