fbpx

Reviving the Minimum Wage Debate (Part 3)

In Part 2 of a series of articles on the minimum wage,  Gordon Lee examines the relationship between minimum wage and costs of production, inflation, productivity and competitiveness. In Part 3 he explores the limitations of the Workfare.

“Singapore has something better than a minimum wage and it is called Workfare.”

- Prime Minister Lee Hsien Loong

What is Workfare?

Workfare has two arms – the Workfare Income Supplement (WIS) scheme and the Workfare Training Support (WTS) scheme*. WIS was introduced in 2007, and WTS in 2010. WTS is self-explanatory – it involves the government subsidising and encouraging training for low-wage earners. The effectiveness of such training schemes (which the government has had in different forms at different times) is highly doubtful.

What seems to be more relevant and important is WIS. To qualify for a government payout under WIS, you have to be:

 

  • above 35
  • earning less than $1,700 per month

The highest payout under WIS is $2,800 a year for those 60 and above, and earning $1,000 a month. But, only $800 is in cash, whereas $2,000 is in CPF.

Incentive to work

What is central to Singapore’s economic culture is that is must always pay to work. Under minimum wage, there is an increase in hourly wages for low-wage earners and hence there is an increase in their incentive to work. This encourages more people to join the workforce instead of being economically inactive (unproductive).

WIS has similar aims, but as always, the devil is in the details. WIS payments are reduced as the income of a worker increases. That is the only way for the system to work, but it comes with an unintended consequence of having a reduced incentive to work once a worker starts earning $1,000 a month.

Let’s imagine someone aged 55 and earning $1,000 a month. Assuming he earns $5 per hour and decides to work more (40 hours more a month) and earns $1,200 a month, he ought to be $200 a month better off. However, out of that $200 a month, he contributes $43.20 cash to CPF[1] and loses $14.25 cash in WIS[2] – which means he only ends up being $142.55 better off a month. The effective hourly rate for his extra 40 hours a month is only $3.56/hr (142.55/40). The low effective hourly rate reduces the incentive for this worker to work.

Let’s imagine a different worker, who is in the same situation as the previous worker, the only difference is that he (for some odd reason) thinks that $1 in CPF is the same as $1 in cash. For him then, we will not bother about his extra $43.20 contribution to CPF, but will focus on his $14.25 cash loss under WIS and a $35.75 CPF loss under WIS. (This CPF loss was not included for the previous worker because he does not care about CPF at all, but this one does.) For this worker then, he is only $150 better off per month, and his effective hourly rate is $3.75/hr (140/40). Again, not a very strong incentive to work.

Modelling WIS


WIS is basically a supply subsidy which encourages the supply of labour. In the above diagram, before WIS, the equilibrium ‘c’ determines wages to be P2 and employment to be Q2. After WIS (the level of subsidy is shown by the distance between ‘a’ and ‘b’), the supply of labour shifts from ‘Supply Pre Subsidy’ to ‘Supply Post Subsidy’ and the new equilibrium ‘b’ means that employment increases from Q2 to Q1. But what is the effect on wages?

Employers now pay their employees less at P1 instead of P2, although WIS makes up for it by increasing the pay of workers from ‘b’ to ‘a’ (P1 to P3). Employers are thinking,:”Employees get a pay top-up form the government, therefore I can afford to pay them less.”

So, WIS does not increase the wages of workers by as much as it seems (P3 from P2), since some of the WIS goes to the pockets of employers by allowing them to get away by paying workers less. This also reduces the incentive for firms to increase their productivity.

Finally, the subsidy causes a deadweight welfare loss so society (total costs to society are more than total benefits to society). Let’s see why.

Total government expenditure on WIS is shown by the rectangle ‘abP1P3’ (subsidy per worker x number of workers). The benefits to employers are shown by the trapezium ‘cbP1P2’, and benefits to employees are shown by the trapezium ‘acP2P3’. There is a triangle ‘abc’ which is unaccounted for – and that is the level of the deadweight welfare loss.

In other words, even though the government spent $386m on WIS in 2008, the total benefits to society (firms and employees) are less than $386m. This is due to the deadweight loss arising from allocative efficiency – which means that spending could have been better allocated to achieve a more effective outcome.

WIS and Minimum Wage

Despite its limitations, WIS is a good step forward. In other countries with a minimum wage (e.g. US and UK), income supplement (similar to WIS) also exists.


If a minimum wage is set at P2 (shown by the green line), employment will fall from the artificial level Q1 to the more natural Q2, since the demand by employers for labour at that wage level is ‘c’ (intersection between minimum wage and demand).

With minimum wage, the deadweight welfare loss is eliminated and the full WIS subsidy goes to employees. Employers no longer have the ability to cut the wages of low paid employees and leave it to the government to make up for it.

Moreover, in order to achieve the same effective wage of P3, the government spending on WIS only has to be the size of the green box, instead of the earlier rectangle ‘abP1P3’. The amount of savings can then be used more efficiently by the government elsewhere - be it investment in education to increase the quality of the workforce, or by investing in infrastructure to support economic growth (and with that, increasing the number of jobs available).

Conclusion

In this part of the series, I have tried to show that WIS has its limitations which a minimum wage can help to overcome by complementing WIS. There is a strong economic case to suggest that the two policies are best used together, as they are in other countries, to achieve a more effective outcome. This can even free up public expenditure by reducing the amount of WIS needed.

In the next and final part of the series – we will investigate the practical ways of implementing a national minimum wage in order to capitalise on the benefits of minimum wage, and mitigate any possible negative effects.

*Workfare Special Bonus, being a one-off payment, is not included.