May 2, 2012

REGION AL

MALAYSIA SINGAPORE INDONESIA THAILAND PHILIPPINES CHINA, HONG KONG

ECONOMIC UPDATE

CIMB Analyst

Minimum wage policy Curse or cure?

Malaysias minimum wage of RM900 per month for the peninsula and RM800 for East Malaysia will benefit some 3.2m private sector workers and arguably, boost productivity by increasing worker satisfaction. Higher wages will release pent-up consumption, albeit with some inflationary impact. Our view is that an appropriate minimum wage could over time achieve a big push, i.e. move the low-wage, low-consumption and informal labour market to a high-wage, high-consumption and formal labour market.

Lee Heng Guie

T (60) 3 20849667 E hengguie.lee@cimb.com

We have prepared a mechanism whereby some allowances or fixed cash payments are allowed to be absorbed in the calculation for minimum wage.
Datuk Seri Najib Tun Razak, Prime Minister of Malaysia

Minimum monthly wage of RM900

As recommended by the National Wage Consultative Council (NWCC), the government has set a minimum wage of RM900/month for Peninsular Malaysia and RM800/month for Sabah, Sarawak and Labuan. This will benefit 3.2m private sector workers (25.8% of total employment) other than those in domestic services. The minimum wage will take effect six months from the date of the Minimum Wages Order is gazetted. Small firms with no more than five workers will be allowed to defer it for a further six months.

Why RM900?
The RM900 minimum wage is 49.9% of the national mean wage of RM1,804.43 in 2010. In setting the minimum wage, the government took into account social and economic considerations: cost of living, productivity, competitiveness and employment. In Malaysia, almost 33.8% of about 1.3m private sector workers still earned less than RM700/month in 2009, well below the RM800/month that is considered the poverty line. Wages have been lagging behind productivity growth, rising 2.6% p.a. versus productivity growth of 6.7% p.a. over the past decade. The new wage rate will have a bigger impact in Sabah (RM800 vs. the current average salary of RM577), followed by Sarawak (RM800 vs. an average of RM758). For Peninsular Malaysia, the new rate of RM900 is 20.4% below the current average salary of RM1,131.

Net positive impact on the economy

Arguably, the higher wage will have a net positive impact on the economy as any potential small loss of jobs will be more than covered by its multiplier effect as it puts more money in the hands of workers, thereby releasing pent-up consumption, albeit with some inflationary impact. There is strong empirical evidence that countries which implement a minimum wage tend to see a positive wage effect and a small negative employment effect among workers covered by the minimum wage legislation.
Figure 1: Minimum wages for Peninsular, Sabah and Sarawak (RM/month)
State Peninsular Sabah/Labuan Sarawak Minimum wage 900.00 800.00 800.00 Current average salary* 1,131.00 577.00 758.00 2010 mean wage 1,739.16 1,565.93 1,630.48 2009 poverty line income 763.00 1,048.00 912.00

*For low-paid workers. SOURCES: MINISTRY OF HUMAN RESOURCES (MOHR), 10MP, CIMB RESEARCH

IMPORTANT DISCLOSURES. INCLUDING ANY REQUIRED RESEARCH CERTIFICATIONS, ARE PROVIDED AT THE END OF THIS REPORT.
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1. Malaysias minimum wage policy 1.1 How it started

In Malaysia, there are three mechanisms that determine the wages of workers in the private sector 1) the Wages Council Act 1974 (WCA), 2) collective bargaining (CA), and 3) market forces. The WCA and CA fall under the definition of minimum wage. But these minimum wages do not provide a decent standard of living and cover only a small number of workers. The existing CAs do not cover the majority of low-paid workers. As a result, wages in Malaysia are largely determined by market forces. Real wages have been low or stagnating because of price controls, subsidies and the influx of cheap unskilled foreign workers.
Figure 2: Distribution of collective agreement (CA) with productivity-linked wage system (PLWS) by sector in 2008-2010
Total number of CA Sector Manufacturing Services Agriculture Others Total 2008 153 112 5 270 2009 159 108 9 276 2010 195 116 17 2 330 -------------No. 108 81 5 194 No. of CA deposited and taken cognisance by Industrial Court 2008 ------------- % with PLWS 70.59 72.32 100.00 71.85 -------------No. 116 80 9 205 2009 ------------- % with PLWS 72.96 74.07 100.00 74.28 -------------No. 144 88 15 2 249 2010 ------------- % with PLWS 73.85 75.86 88.24 100.00 75.45

SOURCES: MALAYSIA PRODUCTIVITY CORPORATION (MPC)

The Malaysian Trades Union Congress (MTUC) has been asking for a wage policy for decades. The minimum wage policy was announced by the Prime Minister cum Finance Minister in the Oct 2010 budget speech. On 30 Mar 2010, the New Economic Model (NEM) proposed the formulation of a minimum wage policy to meet the inclusiveness agenda of the NEM. The objective is to rectify the dysfunctional wage-setting mechanism for low-paid workers. In Jul 2011, the National Wages Consultative Council Act 2011 (Act 732) was passed by the Parliament and gazetted on 15 Sep 2011, repealing the WCA 1947 (Act 195).

1.2 Market conditions favour a minimum wage

Various measures showed that Malaysias labour market is characterised by 1) a high presence of low-skilled workers (70% of labour force), significantly higher than in Singapore (51%), Taiwan (67%) and South Korea (65%), and 2) over-reliance on low-cost, unskilled foreign workers, which have sustained the profitability of low-value-added business activity, giving businesses no incentive to move up the value chain. It also largely contributed to a dampening effect on wages. The National Employment Returns 2009 study initiated by the Human Resources Ministry revealed that 33.8% (Peninsular Malaysia=27.2%, Sarawak=48.1% and Sabah=63%) of around 1.3m private sector workers in Malaysia still earned less than RM700/month. Wages lag behind productivity growth. A study by the World Bank that shows that wage growth was 2.6% p.a. in the past 10 years compared to productivity growth of 6.7% p.a., suggesting suppression of wages, especially for low-paid workers, and also an inefficient labour market.

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May 2, 2012

Figure 3: Highest mean salary for mining and ICT sectors

Mining & quarrying Information & communication Financial & insurance/takaful Education Electricity, gas & air conditioning supply Real estate Professional, scientific & technical Public administration & defence Human health & social work Transportation & storage construction Manufacturing Arts, entertainment & recreation Water supply, sewerage & waste mgmt W/sale, retail trade & repair of vehicles Administrative & support services Accomodation & food service Agriculture, forestry & fishing Other service RM/month 0 1,000 2,000 3,000 4,000

Figure 4: Highest median salary for education and ICT sectors

Education Title: Information & communication Real estate Source: Mining & quarrying Financial & insurance/takaful Public administration & Please defence fill Electricity, gas & air conditioning supply Human health & social work Professional, scientific & technical Transportation & storage Water supply, sewerage & waste mgmt Arts, entertainment & recreation construction Manufacturing W/sale, retail trade & repair of vehicles Administrative & support services Accomodation & food service Agriculture, forestry & fishing Other service RM/month 0

in the values above to have them entered in your rep

1,000

2,000

3,000

Mean of monthly salaries and wages by industry in 2010

Median of monthly salaries and wages by industry in 2010

SOURCES: DOS, MOHR, CIMB RESEARCH

SOURCES: DOS, MOHR, CIMB RESEARCH

1.3 Minimum wages Helping or hurting workers?

There are arguments for and against a minimum wage. The implementation of a minimum wage policy signals the governments commitment to greater inclusiveness and reduces poverty as the income of at least 30-40% of workers currently puts them below the poverty line. Better wages arguably boost productivity growth, which is positive for employers. Meanwhile, those against the minimum wage argue that it interferes with market forces in wage setting, increases business costs and leads to some inflationary impact as higher costs will be passed to consumers.
Figure 5: Better wages boost productivity growth
% 16

Figure 6: Productivity growth was supported by manufacturing and services

%
15 10

Title: Source:

12 5 8 0 4 -5 -10 -15 -4 2006 2007 2008 2009 2010 2011 Agriculture National productivity growth National wages growth* (RHS) Construction Mining Services Manufacturing Overall 2006 2007 2008 2009 2010 2011

Please fill in the values above to have them entered in your rep

*Median of monthly salaries and wages in Malaysia as a proxy. SOURCES: DOS, MOHR, MPC, CIMB RESEARCH

SOURCES: MPC, CIMB RESEARCH

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Figure 7: Services sub-sectors productivity growth

%
12

Figure 8: Personnel cost as % of total cost by sector

% of OPEX 50

8 4

40
40

Title: Source:

Please fill in the values above to have them entered in your rep
30

0 -4
-8

20

<10
10 2006 2007 2008 2009 2010 2011 0 Utilities Accomodation and restaurant Communication Real estate and business services Wholessale and retail Transport and storage Finance and insurance Other services Plantation Construction

9 5-7 6

Rubber glove

Automotive

Breweries

Labour cost as % share of total company's OPEX

SOURCES: MPC, CIMB RESEARCH

SOURCES: CIMB RESEARCH

Figure 9: Productivity growth outpaced wage growth across all sectors in 2010
Healthcare Private education Tourism Business & professional services
Wholesale & retail

Services sub sector

ICT Logistic services Basic metal Motor vehicles Chemicals Refined petroleum E&E Food & beverages
Overall Manufacturing

Manufacturing sub sector

Growth (%)

-12

-6

0 Productivity

12 Unit labour cost

18

24

Labour cost per employee

SOURCES: MPC, CIMB RESEARCH

1.4 Why RM900 per month?

In setting the minimum wage, the National Wages Consultative Council (NWCC) took into account social and economic considerations: cost of living, productivity, competitiveness and employment. Other points that it considered include geographic (different states, regions), economic sectors/industries as well as demographic. The extent to which these factors are balanced can be approximated by some rough indicators such as the level of the minimum wage relative to the median or mean wage or the proportion of workers whose wages are affected by the statutory minimum. As stipulated under the National Wages Consultative Act 2011, minimum wage means the basic wage, i.e. the lowest hourly, daily or monthly wage that employers legally pay employees. Part of allowances or fixed payments will be allowed in calculating the minimum wage. The NWCC set a minimum wage of RM900, which is around 49.9% of the nationals mean wage of RM1,804.43 in 2010. In the UK, for example, the minimum wage corresponds to about half the median wage, lower than 60% of median wages in France but considerably higher than the 32.4% of median wages in the US.

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May 2, 2012

2. FAQ 2.1 How regularly will it be reviewed?

The NWCC will recommend the minimum wage to the government once every two years. We think that a periodic adjustment which takes into account changes in labour market conditions and productivity growth is the key principle of a prudent minimum wage policy. To allow for flexibility as well as unexpected economic shocks, the country should not be locked into a rigid formula for regular adjustments of the minimum wage. Going forward, the government hopes that within the next two to three years, the minimum wage for Sabah, Sarawak and Labuan can be streamlined with that of the Peninsular Malaysia.

2.2 What is a safe level for the minimum wage?

There is no universal answer as minimum wage effects depend on a host of country-specific factors such as labour market conditions and variation in worker productivity across regions, industries and occupations. The RM900 minimum wage is a reasonable threshold, being 49.9% of the national mean wage. A minimum wage that is too high or above the market-clearing level would lead to employment reduction and an increase in unemployment. The minimum wage should not be increased when unemployment is high or rising and is concentrated among low-skilled workers. As a rule of thumb, in developing countries, the national minimum wage should be probably less than 40% of the average wage and roughly not more than one-third of the average or mean wage. The proposed increase in minimum wage should take into account inflation, productivity as well as employment growth.
Figure 10: A reasonable minimum wage range
RM/month 2,500

1,833
2,000

1,987 1,630

1,804

1,739 1,290 1,299 800

1,500 1,310 1,000 900

1,500

1,300

1,200

1,000

Minimum wage range set

500

0 Malaysia Peninsular Sabah Labuan Sarawak Urban area Rural area

Mean wage

Median wage

SOURCES: DOS, MOHR, CIMB RESEARCH

2.3 Who will benefit?

Some 3.2m private sector workers or about 25.8% of total employment will benefit. Many will be from low-to middle-income households. The wage rate will be distributed unevenly, with a RM100 difference between the Peninsular Malaysia and Sabah, Sarawak as well as the Labuan Federal Territory. The new rates will have a bigger impact in Sabah (RM800 vs. the current average of RM577), followed by Sarawak (RM800 vs. average of RM758). For Peninsular Malaysia, the new rate of RM900 is 20.4% below the current average salary of RM1,131.

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May 2, 2012

Figure 11: Median monthly salaries and wages paid by state

RM/month 2,000

1,600

1,200

800

400

Salaries and wages by state in 2010

SOURCES: DOS, MOHR, CIMB RESEARCH

2.4 Which are the groups or sectors will be affected?

All the formal private sector employees will be stipulated under the Minimum Wage Order. Domestic services such as domestic helpers and gardeners will be exempted.

2.5 How will the government enforce it?

A grace period will be given to employers to restructure their wage schemes once the new minimum wage is implemented. The minimum wage will take effect six months from the date the Minimum Wages Order is gazetted. Most firms with five workers or fewer, so-called small-time employers or micro-enterprises will be allowed to defer it for a further six months. The 12-month grace period does not cover professional outfits such as dental and medical clinics and legal, architecture and consultant firms. SMEs will be given the opportunity to apply to the wage council for an extension before the commencement date. In practice, there are several reasons why the effectiveness of minimum wages may be limited. One obvious factor which can limit the impact of minimum wages is weak enforcement. Other factor is simply the risk of mismanagement when minimum wages are set at an unrealistically high level, leading to either non-enforcement or displacement of low-paid workers into unemployment or informal employment. In Malaysia, employers which do not comply with the minimum wage policy risk a maximum fine of RM10,000 per worker. For continuous offenders, they will be fined RM1,000 per day and repeat offenders would face a RM20,000 fine or five years jail or both.

2.6 Will it affect the cost of doing business and hurt Malaysias competitiveness?
We do not think that the minimum wage will hurt Malaysias competitiveness as some 90% of the countries in the world have minimum wage policies. They include Malaysias regional peers such as China, Taiwan, South Korea, Thailand and Indonesia. Furthermore, the minimum wage scheme will only applicable to low-paid workers.

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May 2, 2012

Figure 12: In Asia, Taiwan and Hong Kong have the highest minimum wage
US$/month
2,500

2,000

1,500

1,000

500

Monthly minimum wage for private sector

SOURCES: NATIONAL SOURCES, CIMB RESEARCH

Malaysias competitiveness is a function of a conducive investment climate, predictable economic policies, an array of business-friendly incentives as well as the provision of good infrastructure and skilled workers. The impact on the cost of doing business will be manageable as 1) wages constitute 9.2% of the total cost of doing business, and 2) the minimum wage covers lower-income category, which represents about 20% of total manpower in a company. If labour productivity rises faster than wages, capital and stock owners will benefit. Companies may increase the budget for the training of their workers.

3. Economic impact 3.1 Pent-up consumption

Arguably, the multiplier effect is greater as the minimum wage puts more money in the hands of workers, thereby releasing pent-up consumption. A back-of-envelope calculation shows that an adjustment of RM200 per month for 3.2m workers amounts to an estimated annual income of RM7.7bn. Assume a marginal propensity to consume (MPC) of 0.5, this translates into annual disposable income of RM3.9bn or 0.5% of GDP. As shown in Figure 13, these low-wage workers spend 68-75% of the total household income on basic needs food and beverages (32-35%), housing, utilities and other fuels (28-37%), as well as transportation (3-8%).
Figure 13: Household expenditure by income group
> RM5000
RM4000 - RM4999

Figure 14: Household expenditure by occupation of household

Others Title: ElementarySource: occupations Plant/machine-operators & assemblers

RM3000 - RM3999 RM2000 - RM2999 RM1000 - RM1999 RM900 - RM999 RM800 - RM899 RM700 - RM799 RM600 - RM699 RM500 - RM599 < RM500 % of total monthly expenditure 0 20 40 60 80 100

Please fill in the Craft & related trade workers

Skilled agricultural & fishery workers Services workers & shop/mkt sales workers Clerical workers Technicians & associate professionals Professionals Legislators, senior officials & managers % of total monthly expenditure Food & beverages Transport Others 0

values above to have them entered in your rep

20

40

60

80

100

Food & beverages Housing, utilities & other fuels Restaurants & hotels

Alcoholic beverages & tobacco Transport Others

Housing, utilities & other fuels Restaurants & hotels

SOURCES: DOS, CIMB RESEARCH

SOURCES: DOS, CIMB RESEARCH

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May 2, 2012

3.2 A small negative employment and investment impact

There is strong empirical evidence that countries which implement a minimum wage tend to see a positive wage effect and a small negative employment effect among workers covered by the minimum wage legislation if the wage is set above the market equilibrium level. The precise magnitude of the negative effect on employment is a subject of debate and is likely to vary depending on time, place and the type of job. The NWCC/MOHR studies showed that a minimum wage is expected to reduce the demand for migrants workers by 0.4-6.1% over next four years (2012-15) under monopsony and competitive models if the minimum wage is set at RM900/month and above. Under perfect competition market, the RM900/month minimum wage is expected to increase the countrys unemployment rate by an average 0.4% pt in 2012-14. The impact on investment is very mild with an estimated less than 0.05% decline in total investment rate during 2012-14 when the minimum wage is set at RM900/month.
Figure 15: A minimum wage is expected to reduce demand for migrants workers
Hypothetical wage level (per month) RM700 RM800 RM900 RM1000 RM1100 RM1200 ------- Monopsony model (%) ------ 2012 0.0 -0.1 -0.6 -0.8 -1.0 -3.9 2013 0.0 0.0 -0.4 -1.8 -1.8 -3.9 2014 0.0 0.0 -0.5 -1.6 -1.2 -2.3 2015 0.0 0.0 -0.4 -1.3 -1.7 -3.0 ------- Competitive model (%) ------ 2012 0.0 -0.1 -0.9 -2.5 -4.3 -6.1 2013 0.0 -0.1 -0.7 -2.2 -4.0 -5.6 2014 0.0 -0.1 -0.6 -2.0 -3.7 -5.3 2015 0.0 -0.1 -0.4 -1.7 -3.4 -4.9

SOURCES: MOHR, CIMB RESEARCH

Figure 16: Forecasted increase of unemployment rate by level of minimum wage under perfect competition market
% 3.0

Figure 17: Forecasted change in the investment rate by level of minimum wage
%
0.2

Title: Source:
700 800 900

Minimum wage level (RM/month) 1000 1100 1200

2.5

0.0 -0.2

Please fill in the values above to have them entered in your rep

2.0 -0.4 1.5 -0.6 -0.8 -1.0 -1.2 0.0 600 700 800 900 1000 1100 1200 1300 -1.4 % change in total investment rate (average 2012-2014) Minimum wage level (RM/month) % change in unemployment rate (average 2012-2014)

1.0

0.5

SOURCES: MOHR, CIMB RESEARCH

SOURCES: MOHR, CIMB RESEARCH

3.3 A big push over the medium term

In our opinion, an appropriate minimum wage level would over time achieve a big push, i.e. move the low-wage, low-consumption and informal labour market to a high-wage, high-consumption and formal labour market. As the adjustment of the minimum wage will be carried out on a staggered basis, the inflationary impact, i.e. the cost pass-through to consumers, is likely to be manageable. If the rise in productivity growth matches the rise in wages, this will result in a lower cost of production and companies may absorb the rise in unit labour cost.

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May 2, 2012

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