The concept of ‘pay for productivity’ is well documented in microeconomic theory. According to this concept, the labour market is in equilibrium when the marginal cost (extra cost) of employing an additional person is equal to the marginal revenue (extra production) earned by employing that person (assuming diminishing returns to scale on productivity).
This suggests that if the marginal revenue is greater than the marginal cost associated with employing an extra person, more employees should be hired. Conversely, if the opposite is true, employees should be released from the company if the marginal cost exceeds the marginal revenue. This theory will be tested against real South African data to see, where South Africa is positioned in terms of this equation and what this means for its strategy.
Overall, the median salary increase was greater than CPI inflation between 2010 and 2016. It is important to note that real earnings are the earnings of employees after inflation has been taken into account or in other words, the earnings at constant price levels.
The marginal cost of employing staff (median increases have outstripped CPI) is increasing at a faster rate than the marginal revenue (productivity). In terms of the labour market theory, one would expect that this has had a negative impact on employment between 2010 and 2016, in other words; one would expect the employment stats to erode.
It would appear that the theory has been supported by the South African example presented above. This means that South Africa is following a strategy that is unsustainable. How to counter the increasing number of unemployed South Africans depends on the objectives of the strategy set out to counteract it. Three scenarios exist:
- The real wage increases continue to outstrip the increases in productivity – In this case, more jobs would be shed in the economy in order to bring the marginal cost and marginal revenue back into balance (assuming diminishing returns to scale on productivity). This strategy would be popular with those that have secure jobs but would in effect exclude those without jobs from the economy.
- The real wage and productivity are linked and move together in unison – This would have the effect of arresting the increasing unemployment figures and bring balance to the labour market. The net employment figures would grow at the same rate which would make the current unemployment rate the equilibrium rate of unemployment in South Africa. This strategy would be popular with those that feel the current labour market conditions are acceptable going forward.
- The real wage increases at a rate below the rate at which labour productivity increases – This would be the converse of Scenario 1 and would lead to a decrease in the number of unemployed since the marginal cost of hiring new staff has decreased while the marginal revenue has increased. This strategy would be popular with the unemployed as it would create more opportunities for them. However, the employed people will feel as if their increased efforts (productivity) are not being matched by increased remuneration and would oppose such a change.
The three strategies indicate that no matter which of them are chosen, there will be those in favour and those that oppose the strategy. Ultimately, it is the responsibility of the ruling party to analyse each of these scenarios and take a long term strategic view when deciding the best course of action for the labour market and hence the South African economy.
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