Do We Need the Compulsory Minimum Wage Compensation for Years in Service?

At the beginning of the year 2006, the International Monetary Fund (IMF) raised the question for the abolishment the mandatory wage bonuses in Bulgaria that are defined as a 0.6% of the nominal wage for each additional year in service. The Bulgarian government took the commitment to abolish this regulation in 2004 in an agreement with the IMF. The uprise of the question provoked a number of comments in Bulgaria – in media, on forums and among politicians. Labor unions made a firm position that the minimum service bonuses should not be abolished and they can be removed only if new mechanisms come into force so that the level of the salaries in the private and public sector can be regulated. In the opposite case, all working people will be “doomed” to low wages, they warn.

The government stepped back and the social minister Mrs. Maslarova said that till the end of the year the bonuses will not be removed. This is hardly a wonder because the Ministry Labor and Social Affairs cannot afford to have its image of social responsibility degraded. The politicians preferred taking a popular decision as opposed to keeping their promise before the Fund and making a step towards liberalization of the Bulgarian labor market. In policy, it is known, that the winning ideas are those that are supported by socially famous groups and lobbies, no matter whether they represent the majority of the public or whether they are efficient for the business. That is why it is of utmost importance to discuss the government's decisions and comment on the economic impact of the policies that are being conducted.

The Institute for Market Economics stands firmly behind the position that the legal minimum compensation should be abolished. However, by stating this we are not agents of the “greedy” employers who would rather not pay the employees for their work. On the contrary, there is a real alternative to the existing policy, which can lead to more disposable income for the people. For this purpose it is necessary (and possible having in mind the current fiscal balances) for the tax burden and the social security payments to be reduced and at the same time the labor market to be “freed” from regulations such as the compensation for service, minimum social security payments for different professions, etc. The low wages are only a consequence of the business environment and the current situation on the labor market, and the imposed administrative regulations do not lead to an affective change and enhanced labor paying. We should not treat the symptoms, but the disease itself.

What determines the wage rates?

Back in the middle of 19 century, one of the fathers of the classic school of economics – Frederic Bastiat – wrote the following: when two workers run after one employer, wages fall; they rise when two employers run after one worker. In market economics wages depend on the supply and demand of labor. When there is more demand for labor, the wages grow up and vise versa. This “natural law” cannot be changed, no matter what politicians and union leaders wish and want. The minimum compensation in the wages is just an instrument for redistribution of resources and as such is followed by distortions of the market powers, which affect the behavior of both employees and employers.

Mandatory service bonuses are relics form the past – left from the period of communism when such administrative regulations were the only way to raise the wages to pay for experience, qualification and loyalty. Nowadays, all these factors are taken in consideration when employee and employers negotiate freely on the market and the central-planning mechanisms only harm workers.

By abolishing government regulations and restrictions, a green light would be given to the market mechanisms. Individual bargaining between employee and employer and a human resource policy on a company level is the most efficient way of deciding on the terms of work. Labor is subjective and every person is unique, his/her capabilities cannot and should not be limited into stereotypes and frameworks.

Now, lets have a look at the effects from the existing wage compensation from the point view of the employee and of the employer.

Employees

·         The mandatory bonuses leave the feeling that not the employers but the state is responsible for workers and it should take care of its citizens. The desire to be paternalized from the government distorts the incentives and motivation of people. They have the misleading feeling of safety and are ready to seek their “rights” not by negotiating with employers but by going on strike or abstaining from participation in elections as a protest against the government.

·         Instead of being motivated to improve and advance, the artificial compensation works in just the opposite direction – it discourages many people, as these bonuses are a kind of certain source of income. Empirical studies show that minimum wages substantially reduce training received by young workers – both undertaken to qualify for a job or on-the-job training aimed at improving the skills.

Employers

·         Some employers recruit young people with fewer years of professional experience in order to avoid paying the service bonuses. Unemployment among the elderly is still high due partly to the mandatory compensation. Many of the elderly, although having a considerable number of years in service, do not possess some of the qualifications of the young such as computer literacy or the have a profession for which there is no longer a demand on the labor market. So, they cannot compete on equal terms with the young, as their years in service are a burden for them before employers.

·         Some employers in the private sector avoid the regulation by paying different nominal salaries to their employees so that the compulsory bonuses would not differentiate them. Some of the regulations for the business in the sphere of labor law and the fiscal burden are among the greatest engines of development of the “gray sector“ in the country.

·         Effective programs for motivation of the employees are not 0.6% annual increase of the gross salary for each additional year in service. Thus, there is no room even for competition among employees. Private companies have made up different ways of stimulating and motivating their workers such as bonuses driven by results, opportunities for personal development, creation of valuable business contacts, and personal satisfaction. Focusing of the employer on employees themselves, not upon the regulations of the state (together with the headache to avoid them) will help the workers to much greater extent.

Labor market and efficiency

The mandatory compensation in wages is not a solution to the problems. In economics every event has seen and unseen consequences – incentive distortions and different signals are sent to the market players via the prices of the products and the factors of production. In order for the wages to be increased, the productivity of workers should be increased and there should also be economic growth, which makes the business more optimistic about future, and consequentially, more labor and capital are hired.

One of the arguments in favor of the compulsory service bonuses is that the wages are sticky. That means that they are not affected in the short run by supply and demand of labor and as such, addition to the nominal wages is needed to correct for inflation, e.g. However, the primary cause of the stickiness of wages is not a market failure. The government regulations, minimum wages, intervention of unions, the labour law make the wages sticky. Bulgaria is in the last places by labor mobility indicator as a result of the heavy bureaucracy and the great number of administrative measures and regulations.

Regulations should be conducted only if the benefits from them are greater than the costs and the negative side effects for people. The possible externalities of the regulations are higher unemployment, decrease of the labor force, growing up of unofficial market. In Bulgaria the unemployment among the elderly people is at considerable rates, the labor force tends to reduce and the unofficial market is still a concern.

According to a study conducted by the World Bank, heavier regulation of labor is associated with lower labor force participation and higher unemployment, especially of the young.

Successful relations between employees and employers come from mutual interest, not as a result of compulsory mechanisms and government interventions. When employees improve their skills and qualification, their wages rise as they become more valuable for the company the work for. In this way, people should rely on their own capabilities. In the other case, if we do not trust the market itself, we should rely on the benevolence of the state and hope that the strategies the public officials write are efficient. Unfortunately for those who believe in the government to reduce poverty, the strategies of the central planning do not eradicate the problems and the implementation of these strategies even worsens them.