Economic Policy Review ISSN 1313 - 0544

Centralized Indexing Of The Wages In The Private Sector – Does It Make Sense?

Author: Adriana Mladenova / 26.07.2007
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After several weeks of negotiations, the labour unions and organizations of employer representatives reached a consensus on the recommended rate of indexing of the wages in the private sector. The labour unions first insisted on a rate above 18%, while the employers offered 9.6%. At last, as anticipated, a compromise solution was reached at 12.9%. However, it is important to make the following explanation about the index:

  • 1) It is only recommended, not a mandatory for the private sector;
  • 2) Similar indices will be prepared on a sector level as well. Both of the negotiating parties agree that this percentage does not correspond to the specific characteristics in many sectors of the economy.

Perhaps, many people that work in the private sector, wonder why the media in Bulgaria put such a stress on these negotiations and whether it has anything to do with them. And they have right. In the private sector, it is the negotiations between each individual and its employer that matter, not the decisions of any third parties. The wages are set on individual level, through mutual agreement.

It is true that the factors, that have impact on the businessmen's decisions to pay for labour depend on the behavior of the other participants in the market - on their competitors, stage of development in the sector, as well as on the macroeconomic situation and the dynamics on the labour market. But it is certain that the economic actors in the private sector do not need to be either reminded, or convinced that they should pay attention to the market signals and to change their strategies accordingly. All attempts that have been made by government to impose its centralized decisions on individuals, contradict to the logics of the free market. It is the individual actors that serve as a conductor of the market signals by which people coordinate and equilibrium is reached in the economy between demand and supply.

The formula, by which the rate of 12.9% has been calculated, is nothing more than just a mere arithmetic calculation, without economic reasoning behind it. The index is a sum of the inflation rate for the previous year, 75% of the increase rate in the productivity of labour, and weighted-average parameters that are supposed to reflect the competitiveness and the market situation in the country. There is not, and there cannot be, logical justification of the weights in the formula and the usage of historical aggregate data, that does not carry information about the future, or the true perceptions of the economic actors. The same result could be achieved through arithmetic calculation using random numbers.

The wages in the private sector do depend on the inflation and the productivity of labour, on the quality and quantity of labour force and the expectations of the entrepreneurs about the development of the market. However, the proposed formula reverses cause and effect. The productivity of labour increases in these companies, where the managers invest in physical capital and new technologies, in training of their employees and managing more efficiently the resources.  However, if firms raise wages and thus, increase costs, this may deprive them of the chance to make any other investments, which may enhance the productivity in labour in the long run.

The pressure by the labour unions for increasing of wages in the public sector, and for minimum indexing of the wages in the private sector can only be of harm for the workers. The increase of the salaries of drivers working for the public transportation company, served as a catalyst for such demands by other groups in the public sphere. Higher wages, without economic reasons, cannot improve the standard of living in the country as a whole, just vice-versa.

This is what meant the finance minister Plamen Oresharski by saying that, even if wages do rise in nominal terms, their true purchasing power may decrease. If requests, which have been sent to the Ministry of Finance for increase of wages in the public sector are accepted, which by now account for 1.2 billion leva, a crises similar to that in 1997 may occur (when there was a hyperinflation in the country and massive bankruptcy of banks due to printing of money and loose monetary policy).

Employers in the private sectors do not need to be taught how to index the wages of their workers. In the private market, legitimate are these decisions that are taken by mutual consent between the two parties. Therefore, employees should not rely on the government or someone else to negotiate the terms of the working conditions for them, but to defend their own interests.