We Only Get Wealth from Work

January 8, 2016

Jan Rutkowski Gazeta Wyborcza

Patrycja Maciejewicz: A politician walks out to the scene and says: the Poles are not paid enough, they should earn more. Everyone will agree.

Jan Rutkowski, Lead Economist, Social Protection and Labor, World Bank: Everybody thinks there is some sort of a magical way to increase pay in Poland. Everybody also thinks they earn too little.

PM: Is that strange? 

JR: Well – too little compared to what? We have a tendency to compare ourselves to UK or Germany, where Poles go to work and earn money.  The State can do two things. First, increase the minimum pay to West European levels. But that would be catastrophic for the businesses. Second, significantly increase pay in the public sector. But that would have to be financed from higher taxes. Moreover, it would trigger a spiral of pay demands in private sector and fuel inflation. Both methods are utopian.

PM: But we want to earn more. How could it be achieved? 

JR: There is no magic way to increase the living standard. Wages and salaries can only get higher if GDP increases. Sometimes I hear, that GDP is something only economists care about, and what is important for the ordinary people is their welfare. However, people cannot live better if GDP does not increase, there was no such case in known history.

Our wellbeing depends on the GDP, although, of course, the manner in which GDP is distributed is important. Wealth comes from work. Our incomes depend solely and exclusively on the value of what we produce as a society. On GDP per person employed, which is called aggregate labor productivity. Let me emphasize: aggregate. Because whenever the term “labor productivity” is mentioned, people immediately react “What? They want me to work even harder?". We could all work hard and yet have low aggregate labor productivity if the economy is not modern.

PM: We produce cheap things. 

JR: And usually not very advanced technologically. The greatest added value is where the product created is state of the art, attractive, better than others, one that everybody wants. The best example of that is the iPhone – its price does not reflect the cost of raw materials, but rather the idea, design, brand, desirability scale. Apple can pay its employees more, because it manufactures an expensive product from cheap materials.

Besides product quality, technology and labor organization do matter. Productive work does not mean hard work. Productive work is work that results in a high value product. In order for work to be productive, you need a productive, modern factory (metaphorically, factory-economy), and for that you need capital. We still have to accumulate it, to reduce the distance to Western Europe.

PM: When I hear “capital”, I immediately think of a capitalist, who has the money but won’t share. The owner could say: “I’ll take fifty percent less, and distribute the rest among the employees"? 

JR: There is a widespread belief, that our earnings are low, because the owners take away our money. And if their earnings were cut, we would earn much more. But those epitomical rich capitalist – presidents of banks and large companies – are just a fringe. In Poland, the majority of companies are small. In those, the boss still earns more, but disproportions are not that great. Salaries would not get higher if remuneration of company owners or managers were cut. And by the way, nobody is upset by earnings of e.g. coaches and football players. If anything, there is a murmur of admiration. But if an entrepreneur earns the same amount, we automatically feel it was at our expense.

PM: All right, so self-limitation of a millionaire would not result in any gains for me. But his pay is disproportionately high, it is glaring. The economists have a term for it: income inequality. To what level are those differences justified? 

JR: This depends on the cultural context. Tolerance for inequality is greater in the USA, in Nordic countries noticeably lower.  In the US people agree, that a high class manager must make a lot of money. USA attract the best of the best, and pay them a lot; on the other hand, they attract those poorest, least qualified. Immigrants. Thanks to this, they have a very high employment rate. But at the price of high inequality.

The optimum level of inequality is motivating, and not demotivating. When inequality of pay is too great, we cease to believe in our success. If it is too small, we do not feel like making the effort. Every employer must decide, how much to pay a committed employee and how much a weaker one. It would be difficult to assume, that the employers, as the overall group, are irrational. If an employee with a specific skillset is difficult to find, you have to pay them a sufficiently high amount.

PM: Isn’t it just a theory, though? People hear: "There are no raises and there won’t be any, because I have ten other candidates to take your place ". 

JR: It is certainly the case if we talk about low-skilled jobs. People with higher qualifications are more difficult to replace. A good manager, IT specialist – but also a good electrician or chef – must be remunerated at an appropriate level.

PM: Appropriate, meaning fair? We have a huge number of people making minimum wage. 

JR: Appropriate means the level, at which the employee accepts the job and feels motivated. It is an economic approach, which is not always the same as social perception. If someone’s pay is too low, they either don’t work very productively or they look for another job. Verify their skills in the market.

There is no single measure of fair wage. As per economic theory, an employee should receive the equivalent of his contribution to the value of the product the company is making – e.g. chairs that he assembles. However, if I earn 2 thousand PLN as a carpenter, I feel differently when comparing myself to my neighbors, who make 1,5 thousand PLN, and differently when comparing to  someone, who receives 1,5 thousand EUR for the same work.

Fair wage should ensure an appropriate living standard. It is obvious, that by West European standards, the minimum wage in Poland is low and in this sense it is not “fair”. On the other hand, surveys show, that a large portion of the minimum wage earners are so-called second earners, such as son, daughter or wife. Minimum wage does not always mean poverty.

Minimum wage is low by definition, it is the bottom of the ladder. In wealthier countries, you can buy more for it, in poorer ones – less. And Poland is still one of the poorest countries in Europe and this must not be forgotten in the discussion about pay and income. In order for us to start earning more, our economy must first become more advanced and modern.

PM: How much should minimum wage be? 

JR: A safe threshold is approximately 40 percent of national average. There is a pressure to increase it to 50 percent. This would result in a situation, in which some of the people with low skills, e.g. young people without experience, would not be able to find employment, because they would be too expensive for companies. Not for bosses of large corporations, but for small enterprises, producing for local markets, in the poorer regions of Poland.

Minimum wage should be differentiated regionally. 1,5 thousand PLN means a different thing in rich Warsaw and a different thing in the poor Podkarpacie region. Just look: salaries in the public sector are uniform across regions, and while in Warsaw it is difficult to find good candidates, in Rzeszów people are lining up to work in public offices. This distorts the labor market.

PM: Is minimum wage fair? 

JR: An economist will not answer such a question. What I can do is assess whether it is determined in a rational manner, whether it takes into account labor productivity. If employees receive less than the value of what they create, it is exploitation and abuse.

Polish capitalism is quite harsh. We are at the capital accumulation stage, anyone who runs a business wants to make money as soon as possible, compensate for the effort and risk. Sometimes, this is done at the expense of employees, especially in the areas where jobs are scarce.

PM: Why not look at Sweden and do as they do – more social welfare, protection, less inequality. 

JR: It cannot be transplanted just like that. In Sweden, rural communities were always very strong. Local democracies, high social capital. The Swedes are willing to pay taxes, they trust the state to give them something in return. On the other hand, the state trusts, that the majority would not abuse social benefits. That when given the choice: work or benefit, they would not choose benefit.

PM: And we would fail at that only because of non-Swedish mentality? 

JR: Not only that! Institutional and economic factors are more important. We have a chance to build a welfare state, if we create a modern, productive and competitive economy. In history there was no case of a poor country building a welfare state. You need to achieve a certain level of economic development first.

In Sweden, until the 1950s, the economy was liberal, free market based. Only after Sweden got out of poverty they started building the welfare society. Sweden was one of the wealthiest countries in the world back then. 20 years later it turned out they went too far with social spending, and the system started cracking at the seams. Social spending levels had to be reduced. We are one of the poorest countries an Europe. And we have to work for our wealth, because wealth comes from work. We work the longest among Europeans, because we want to make a “quantum leap”. A country, which wants to catch up with the leaders has no choice. In fast developing Asian countries, with which we have to compete, people work even longer. There are no shortcuts to prosperity.

PM: But you said yourself that distribution of fruits of that labor could be different. Today, wage share in GDP is very low compared to Europe. 

JR: It is an important indicator, but we must be careful when interpreting it, and allow for structure of the economy. We also have to remember, that the wage share does not include the self-employed and farmers. There are many of them in Poland, so the wage share in GDP is by necessity lower than in countries where the share of wage and salaried employment is higher.

Wage share in GDP is falling everywhere. International Labor Organization explains, that it is related to technological progress, as technology becomes less labor intensive. Bargaining power of labor was reduced in comparison to capital. Capital is very mobile, far more so than people. It is sad, we may be outraged about it, but in a global world there is no escape from it.

PM: Junk contracts are not bad? 

JR: They are abused. If people do the same job, but some of them have regular labor contracts while others have irregular contracts, this means unequal treatment and is not fair.  But to a large extent we owe the increase in employment and decline of unemployment during crisis to flexible contracts, which you call junk contracts. Is it better to have irregular, flexible contracts, but more people employed, or is it be better to have only regular contracts but fewer people employed and earning income?  This is a real choice.

From the individual perspective, irregular contracts may be bad, but from the broader perspective of the availability of job opportunities, they are not. Of course, there should be no abuse. In many cases, the use of irregular contracts instead of regular labor contracts is not justified by the nature of work.

One way to reduce inequalities in treatment of employees is to introduce a single contract. Such contracts would eliminate division into fixed term and open ended contracts, because they would all be open ended.  Irregular contracts would play a marginal role, and the onus of justifying the use of such a contract would be on the employer.

However, single contract is a concept that has not been verified in practice yet. The only country to introduce it so far has been Italy. In other countries, trade unions protested against it, and so did the employers, because single contract reduces their flexibility in hiring employees.

PM: Trade unions? 

JR: Of course. Because trade unions mostly represent persons who have regular labor contracts.  And single contract offers less job security than currently used open-ended contract. In the case of single contract, employment protection has the form of a severance pay, which increases with job tenure. An employer would have to think twice before terminating employment. But if a worker accepts the severance, he/she waives the right to contest the validity of dismissal in court.

PM: What could the state do to help people? 

JR: The state has a very limited impact on real wages and salaries. It may, however, redistribute income. It may apply tax policy to increase the burdens on the richest and transfer the funds to the poorer ones.  It can reduce income inequality.

However, the poorest groups are not necessarily the ones to benefit from redistribution. Social benefits, such as tax breaks or free of charge higher education, often accrue to more affluent people. The best policy is one that makes it profitable for employers to hire workers, and makes it more attractive for people to work than to collect benefits.


Originally published in Gazeta Wyborcza on 5 January, 2016.