Sunday, 18 May 2014

Wage Increases: Productivity, Profits and Inflation. [J.M. MARTIN]

Chief Economist

On May 11, 2014, the French newspaper Le Monde published a story about the critique of wage increases that had the head of the Société Radiale, Mr. Gattaz, current chief of the business association MEDEF (Movement of French Enterprises) of 29 %, whereupon he came out to defend that position.

First, he indicates that the increase is divided into two parts, the fixed wage in 3 % and variable wage in 26%, while the wage of his employees increased by 3.3 %, taking it all in consideration the recent French inflation will be around 1% .

The criticism rests essentially on the disparate increase has enjoyed this "boss of bosses " in the French business sector over other workers, which revives the old debate of what should be the determinants of wages .

Thus, some critics demand that wages continue exclusively on inflation, for which annual increases should be on average 1% according to the latest data of the French economy . This seems reasonable , assuming that worker productivity is properly determined and is constant, and the stability of the profits of the company.

However, productivity and profits should also be considered in the analysis of wages, among other variables. In this regard, the basic economic theory considers the relationship between real wages (ie , nominal wages indexed prices) and the marginal productivity of a worker. If he's more productive, he should definitely get a higher salary.

Though, one should note that productivity can be understood as a general or individual element, in other words, as the productivity of the worker contribution to the company or the production of the worker in relation to the goals and objectives set. The second concept seems to be more related to the effectiveness or efficiency of production, rather than productivity itself.

Therefore, it should be clear that productivity is originally conceived as the contribution of the worker to the firm; thus, it follows that those who provide added value to the product or service are the ones who should receive higher pay. This reasoning is contrary to one allowing high wage to the workers or workers who are on the basis of productivity chain, since their contribution, although no less important nor irrelevant, does not provide added value to the good or service.

Consequently, the problem is to distinguish the importance of workers who process the product from the productivity that they can generate, since their role is essentially operational or mechanic. At this level, most likely the client managers, administrators, researchers, business developers and managers, are the ones who will finally add value.

Notwithstanding, it is possible to observe industries where the main value added comes from workers that extract or process a product or service in which they are more analysts than mechanics, so following that logic, they should receive a higher paid than middle managers or executives.

Moreover, it is interesting to understand the impact of the company's profit on wages, which can be induced by productivity or other various factors. Thus, it's widely known that there are mechanisms in which administrators receive a variable remuneration and/or participation from in profits in large companies .

In the present case, it seems strange that if Mr. Gattaz received a variable remuneration dependent on his share of profits, why this benefit haven't been received by other workers. This suggests that Mr. Gattaz' labor or commercial contract is possibly one more favorable than a regular labor-profit sharing scheme, which is not unusual in countries with more modern commercial contracts. 

And on the other hand, inflation then plays a minor role in the increase (or decrease) in wages, as long as this remains low in the country which has the productive-contractual relationship. In theory, this indexing should actually performed because otherwise will imply an inconsistency between the actual worker productivity and implied productivity from their salary (not indexed).

Finally, these discussions about "excessive" wage increases should be weighted according to the role that the worker, employer or principal in the company have, not only from a hierarchical point of view but from the importance in creating added value that is it really worth the higher salary. Also, it should be remembered the importance of determining what kind of legal-economic relationship (work/business) has an employee, because depending on this, the remunerative logic may be drastically different. Notwithstanding the above, it appears that in any case necessary, wages shall be indexed to inflation to avoid distortions in productivity. Of course, this opens the door to a discussion of theory and monetary policy that will be the subject of another post .