Economic Policy Review ISSN 1313 - 0544

The Magic Formula for Wages

Author: Adriana Mladenova / 29.01.2007
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Social policy minister Mrs. Maslarova is obviously determined to oppose market logic despite appeals from both the IMF and EU for the liberalization of wages and the abolishment of minimal seniority bonuses in Bulgaria. Last month, she proposed a new formula, which aims s to link the nominal growth rate of the salaries to certain indicators. This formula would be a compromise solution after the abolishment of the compulsory seniority bonuses and was proposed before the National Council of Three-party Cooperation.

The formula states the following: the basic salary accounts for about 70% to 80% of the remuneration, compensation for hard conditions of labor - between 5% and 20%, and up to 10% of the wage comes from seniority and experience bonuses.

The negative effects of the formalization of the wages have two-sided. On the one hand, the majority of voters are discontented with the proposition, because they believe that the indicators are not reasonable and fair enough and do not match their subjective notions about the price of their labor. On the other hand, such a reform will have a negative effect on the business environment although it will not be mandatory, only recommended for the private sector. The establishment of rules for the formation of labor costs contradicts the ideas of market economy and established practices even in the European Union, where the labor market is characterized by its over-regulation in comparison to the USA. Such a formula does not encourage workers and employers to negotiate the optimal rate of remuneration rather than relying on government rules. The wage rate should depend on the nature of the work, the abilities and characteristics of the employees. The proposed parameters of the formula are not fair to many people because they perceive themselves as “doomed” to get paid according to the ideas of the government, which may not necessarily match their own ideas. But the fact, itself, that there is such a formula leads to a culture of dependency and makes employees willing to ask the government to protect them against the unjust rate of wages.

Economic justification of the proposition

When a mechanism for government intervention in the market is proposed, an impact analysis should be made for the benefits and costs of it for the general public. So, the question comes – how are the parameters of this formula derived? Why exactly 10% for seniority bonuses, for example? This case is impossible to justify, because there is no sense in trying to determine wage rates on a national level. Modern forms of work payments in developed countries depend on many criteria such as efficiency, education, experience, and skills, and include various types of compensation, such as employee options and shares of the corporation, result-orientated payment, retirement and healthcare benefits, etc. But unlike the government, company managers are able to evaluate the effects of such strategies depending on the characteristics of their business and the aims they pursue. In short, what is really fair is for everybody to be able to receive what he or she earns and to have the opportunity to climb up the hierarchy ladder based not only on years of experience and formal position characteristics, but also on qualifications and results.

There is no magic formula in the sphere of labor policy and Minister Maslarova should not even try to invent it just in order to receive the approval of a part of the voters. On the contrary, it is necessary to defend and promote publicly the idea that the salaries should be liberalized, should be relieved from all relics of planning, and should be left to the free market and to the negotiation mechanisms between employers and employees. The ruling bodies can assist this process by optimizing the expenditures of the government administration, but not by undertaking activities such as inventing formulae where market processes rule and decrease the ineffective government costs and taxes. This optimization is the fastest, most efficient and established way to increase the revenues of the population. The same stands for labor unions – they should try to help, not hinder the life of the people whom they claim to represent.

Control over wage rates is to some extent necessary for government-owned enterprises, but this is only one sign of the problems that exist in the management and functioning of state-owned companies. They are characterized by soft budget constraints, inefficient production and management, and financial instability. The problems will be solved only when companies are privatized and enter the competitive environment of private business.

Even if the proposed ordinance is accepted, the formula will not dominate in the private sector and entrepreneurs will find ways to evade it, because market powers are stronger than the attempts at artificial restrictions, which are rather irrational and inefficient. But the public debate on such issues implies ideas that are adverse for the establishment of market processes. Confidence in the free market and in the private sector is vital for the creation of entrepreneurial attitudes and business culture in the economy. One should know that faith in one’s own abilities and qualities, not in the state, is the driver of the innovative spirit and economic prosperity.