The wages of corruption and the corruption of wages

The author is the dean of the College of Business and Economics of De La Salle University.

The Gospel according to Luke (10:7) says: “The worker is worth his wage.”

But consider a pair of identical twins who go to the same schools, take
the same courses, and end up working in the same company. If one twin
is stationed, say, at the London office, he is likely to receive a
higher compensation package than his brother who reports to the Manila
office – even if they are assigned to the same job cell.

If the Gospel speaks the truth, why are workers who are identical in all things except office affiliation paid differently?

Ask a labor economist and chances are you will get an earful on (a) the
demand for labor being a derived demand, (b) the elasticity of
substitution of labor and other inputs and their relative prices, (c)
differences in reservation wages of workers and in their marginal rates
of substitution between goods and leisure, and (d) the relative
configurations of the market labor demand and supply curves and the
wage elasticities of labor demand and supply. (Readers who want a more
detailed exposition of these concepts can consult standard labor
economics texts, such as Borjas, Labor Economics; Brue, MacPherson, and
McConnell, Contemporary Labor Economics; and Ehrenberg and Smith,
Modern Labor Economics: Theory and Policy.)

These models argue that: (a) The demand for labor stems from its
contribution to the production process. The higher the demand for the
final product, the higher the demand for labor. (b) Technology – the
feasible ways of combining inputs into outputs – and the input price
ratios determine the intensity with which production factors are used.
The easier it is to replace labor with other inputs and the more
expensive the wage rate is relative to the prices of other inputs, the
lower will be the labor intensity of the production process. (c)
Workers weigh the trade-off between consuming goods and enjoying
leisure. The higher a worker’s reservation wage (the wage that will
entice him to join the labor force), the less likely he will want to
work and the higher will be the wage required to induce him to work.
(d) The higher labor’s market demand curve, the lower is its market
supply curve, or the higher the absolute values of the wage
elasticities of demand and supply (or responsiveness of wages to unit
changes in hours worked), the lower will be the market clearing wage
rates.

Applying these models to the analysis of differences in wages between
Manila and London, one comes up with the following story: In both
places, workers are paid wages equivalent to their contributions (at
the margin) to profits, so the Bible passage is true in some sense. But
the London-based worker is paid much higher than his Manila counterpart
because the marginal value of his contribution is higher. The reasons
for this differential include: (a) the generally stronger demand for
goods and services in London than in Manila, which implies that the
demand for labor is higher in London; (b) the rising elasticity of
substitution of labor relative to other inputs (The Woody Allen joke
here goes, “After 20 years of working in the same company, my father
was retired and replaced by a gadget. When my mother heard about it,
she immediately went out and bought one.”), which effects a declining
demand for unskilled labor and rising compensation for skilled labor;
and (c) the more rapid downshift in Manila’s labor supply curve due to
unabated population growth.

My problem with this storyline, however, is that it is unsatisfying
from a policy standpoint. Blaming low wages on weak demand for goods
and services and on runaway population growth effectively absolves
policy makers from acting on the problem, since the first reason can be
due to many things, including lack of incomes, high prices, lack of
access to markets, lack of information, and shocks from other economies
or the natural environment (e.g., El Nino dry spells), and the second
reason is politically touchy, given the Catholic Church’s long-standing
opposition to artificial birth control.

So let me offer an alternative explanation, one based on the circular
flow of incomes and goods and the distribution of factor incomes. One
of the simplest models in macroeconomics, the circular flow of incomes
and goods holds that the economy consists of households and firms.
Households own all factor inputs, which they rent out to firms to earn
incomes. Firms hire the factor inputs to produce goods and services,
which they sell to households.

Using the circular flow model, one can think of firms’ activities as
generating an economy’s pie of goods and services. The same model also
explains how this pie is divided up among households. The allocation
rule is simply that a household’s share of the economic pie depends on
the proportionate amount of utilized production factors that the
household owns. The more labor services, land and capital a household
owns which are used in the production process, the greater is that
household’s share of the economic pie.

There are two important points about the economic pie and how it is
divided. One, the allocation rule must specify the relative weights of
the different assets employed in terms of their claims on the economic
pie. In other words, the rule must state how much of the pie one
man-hour of labor (or one machine-hour or one land-hour) is worth. In a
market economy, these weights are wage rates for labor, rental rates
for land areas and buildings, and interest rates for physical and
financial capital. Two, the size of the pie determines the actual
rather than just proportionate value of each slice. (Think of a single-
and a family-size pizza divided, say, eight ways. While each slice is
one-eighth of the pie it comes from, the slice from the family-size pie
is bigger than that of the single-size.)

How does this model answer the question at hand? Since the economic
pies of developed countries are much bigger than those of developing
countries, their workers receive much bigger slices, even if in
proportionate terms the slices (or weights) for labor may be the same
in all countries.

The significance of this insight, however, is that it yields a narrow
and focused agenda for economic managers of developing economies: Grow
the pie, so there is more to spread around.

Unfortunately, on this criterion, the Philippine record is dismal.
Since the 1980s, the economy has never exhibited an annual growth rate
of six percent or more. At an average annual growth rate of six
percent, the economy takes 12 years to double the pie; at four percent,
it takes 17 years.

One reason why the Philippine economy has not grown as fast as other
countries in the region is the rampant graft and corruption that has
persisted through two People Power uprisings. Corruption confiscates a
chunk of the pie before it is distributed. This leaves less for owners
of employed factors to share among themselves, which kills their
incentive to put their resources to productive use. The wages of
corruption in a society that tolerates it are the debasement of wages
and incentives, which in turn stunts the growth of the country’s
economic pie.

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