Download the inability of small firms to generate employment in a high wage

THE INABILITY OF SMALL FIRMS TO GENERATE EMPLOYMENT IN A HIGH WAGE
REGIME: THE SOUTH AFRICAN WAGE CURVE AND IMPLICATIONS FOR WAGE
SUBSIDIES
Dieter von Fintel (Stellenbosch University): [email protected]/ [email protected]
Magruder (2012) notes that there is a "missing gap" in the number of small firms
operating in South Africa due to collective bargaining agreements that raise wages
beyond what these firms can afford; furthermore, he shows that collective bargaining
councils causally increase both wages and unemployment. This apparently positive
relationship between local unemployment and wages stands in stark contrast to the
wage curve (Blanchflower & Oswald, 1994) –which posits the relationship to be
negative, andthat has been put forward as an empirical law of economics. Kingdon &
Knight (2006) establish directly that a wage curve exists in South Africa, despite the
apparent positive relationship noted elsewhere.
This paper first proceeds to show why their result does not hold. It is evident that districtlevel heterogeneity (which Kingdon & Knight's data is unable to fully account for) drives
the result. Secondly, it illustrates the mechanism by which the wage curve is “prevented”
from operating as an adjustment mechanism in the labour market. One of the
innovations of this paper is to account for district-level wage dispersion. Lower
dispersion is found in districts where average wages are higher, suggesting that there is
a compression of the lower tail of the earnings distribution, associated with an absence
of small firms. Once controlling for this and other measures of industrial structure and
unionisation, the wage curve re-emerges, suggesting that large firms and collective
bargaining are driving up wages and unemployment simultaneously. The implications of
this study support the introduction of a wage subsidy as a policy measure. It is evident
that small firms cannot create jobs at high prevailing wage rates. While the existing
policy proposal has been targeted towards young recipients who struggle to make the
transition into the labour market (on the labour supply side), it is evident that an
alternative effective route could be to target small firms with wage subsidies (on the
labour demand side).