Structural Challenges will limit Impact of Higher Minimum Wage

Higher minimum wage necessitated by weaker purchasing power of employee compensation

Impact of Higher Minimum Wage
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On 18 April, President Muhammadu Buhari signed into law the Minimum Wage Repeal and Re-Enactment Act 2019, which prescribes an upward adjustment in national minimum wage to N30,000/month (US$83.3)from N18,000 (US$50.0).

The 67 percent increase in minimum wage follows months of agitation by the labour union which, in our view, is not misplaced, considering the purchasing power of the previous minimum wage more than halved between 2011 and 2018.

Nigeria’s labour productivity barely grew within the period, with data from the National Bureau of Statistics (NBS) showing per unit labour productivity (real output of employed population per hour) grew in real terms at a rather underwhelming Compound annual growth rate of 1.2 percent between 2011 and 2016.

However, our analysis reveals labour unit cost (real compensation of employed population per hour) fell at an annual rate of 4.2 percent within the same period. This implies that unit labour cost has not kept up with the modest growth in productivity since the previous minimum wage was passed in 2011.

 

Impact on medium term growth limited by slack labour market and weak fiscal revenues

Although we expect the increase in minimum wage to have a positive knock-on impact on consumption expenditure-which has stagnated in recent years -the policy falls short of deeper fiscal and economic reforms required to lift medium growth outlook above 3 percent level.

Our conclusion rests on two arguments. First, the capacity of the Federal Government (FG) and sub-nationals to fund higher personnel costs without reducing public investment in human and physical capital is limited.

This is against the backdrop of unresolved revenue challenges, reflected in limited fiscal space to raise aggregate expenditure or significantly increase deficit spending. Secondly, the private sector will struggle to implement the new minimum wage in the interim, considering that the timing of the wage increase coincides with a period of weak corporate profit and slack labour market.

According to NBS data, unemployment rate rose to a record high in the third quarter of 2018 (23.1%) while operating surplus in the economy weakened in 2017 and first half of 2018 by 2.1 percent year-on-year and 3.0 percent year-on-year respectively.

Given the minimum wage is targeted at employers in the formal sector with more than 25 employees, voluntary compliance by the larger informal sector (estimated at 50-60 percent of GDP) will likely be low until the recovery in the economy gains momentum.

As we noted in our fiscal policy update last week, the impact of the increase in the minimum wage on the FG’s budget might not be substantial (current estimate –N200bn) as the wage increase will likely be passed on moderately on other salary grades. A much higher jump in minimum wage in 2011 (+140% to N18,000 from N7,500) resulted in a 16 percent or N245.76bn increase in personnel cost over 2-years post-implementation.

In addition, the Federal Government can continue to rely on access to deeper and diversified funding sources (either through monetary financing, local and external debt market) to continue to meet higher operating expenditure (OPEX) obligations.

Sub-nationals, however, do not have the same luxury. According to BudgIT, 18 out of 36 states were unable to cash-back recurrent expenditure with revenues generated (Federation Accounts Allocation Committee (FAAC) and Internally Generated Revenue) over first half of 2018.

As such, our baseline expectation is that compliance by sub-nationals (states and local governments) will be underwhelming at first, while there may be aggressive push by state governors for revenue measures (VAT increase or removal of petrol subsidy) to create fiscal headroom for funding higher OPEX.

 

The productivity question: balancing funding for higher wages with investment financing needs

With the FG likely to delay aggressive revenue measures until a new cabinet is formed in the fourth quarter of 2019 to 2020, the more likely scenario is for fiscal authorities to continue to prioritize personnel expenses over capital expenditure and human capital investment.

The downside to this is the longer term feedback on economic productivity and competitiveness. Nigeria’s labour productivity seems to have stalled over the last decade and barely kept pace with frontier markets in Asia and East Africa.

According to data compiled from the International Labour Organization (ILO), Nigeria’s output per capita (GDP constant 2010 US$) grew at a CAGR of 0.4 percent between 2011 and 2018, slightly ahead of Sub Saharan Africa (SSA) region (+0.3%) but behind high growth markets in Asia (ASEAN: +3.7%) and East Africa (Kenya: +1.9%, Rwanda: +4.0% and Ethiopia: +5.6%).

In our view, prioritising higher minimum wage without addressing the broader productivity challenge could worsen the competitiveness of the Nigerian economy as authorities aim to double the contribution of manufacturing sector to GDP to 20 percent by 2025 from 9.5 percent.

Nigeria faces acute infrastructural challenges in power, transport, and roads limiting growth potential. Notably, capital formation as a ratio of GDP has declined by 5ppts over the last decade to 13.7 percent in 2018 and trails both SSA average (20.2%) and Emerging and Developing Asia (40.2%) according to data from the International Monetary Fund (IMF).

Financing investment across priority areas in infrastructure, education and healthcare will be key to unlocking productivity gains and growth capacity over the medium term.

 

Will the wage increase lead to a turnaround in consumer sentiment?

Nigeria’s much vaunted household consumption expenditure has been under pressure over the past four years in the face of high cost inflation and the economic recession in 2016 which weighed on real income.

According to the NBS, aggregate employee compensation fell by a cumulative 18.5 percent in real terms between 2014 and 2016, thus forcing consumers to downsize to cheaper products. The impact wastelling on household consumption spending which contracted 5.7 percent year on year in 2016.

Fortunately, greenshoots of recovery are appearing, with NBS data on national accounts showing a remarkable rebound in real income between 2017 and 2018, thanks to the recovery in oil prices which have stabilized fiscal and external accounts.

Nonetheless, the impact is yet to fully translate to consumer sentiment. Household consumption spending contracted 1.0 percent year on year in 2017 and grew by a soft 0.3 percent in first half of 2018. The big question is if the increase in minimum wage will be the catalyst for stronger real wage growth and turnaround in consumer sentiment. We have a nuanced view on this.

As we noted earlier, the minimum wage increase itself is not enough to lift short to medium term growth prospect above 3 percent without structural reforms to unlock productivity. Nonetheless, similar to the scenario hat played out in the aftermath of the wage increase in 2011, we expect to see some re-allocation of national income from operating surplus to compensation of employees.

This could unlock additional N500bn –N700bn increase in nominal compensation to workers beyond steady state growth, depending on the level of compliance by sub-nationals and the private sector.

Increase in minimum wage is typically targeted at low and lower-middle income classes that spend a disproportionately large share of income on household essentials. This implies that producers of consumer durables (food, pharmaceuticals and apparels) and to a lesser extent, consumer non-durables, stand to benefit more.

As such, we expect industry revenue to recover in the FMCG sector over Full year 2019/2020 on the strength of improving household spending, bolstered by higher real wages and stable exchange rate.

However, the impact on profitability may be constrained by higher wage inflation, increasing competitive pressure and the likelihood of the government taking revenue measures to reduce fiscal imbalances.

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