Perhaps even if you still don’t agree with our arguments about minimum wages and pay equalisation, maybe you can agree that artificial interference in the market by governments only tends to create another problem while claiming to solve one problem.
We’ll bang on about it for one last time today. If you’ve had enough already then I suggest you give today’s Money Morning a miss. Join Shae again tomorrow for Money Weekend, or we’ll see you again on Monday where we’ll bang on about something else.
To our way of thinking, there’s no difference between pay equalisation and minimum wage legislation. Both create artificial wage markets which aren’t sustainable over time.
So today we’ll take another bash at the ultimate job killer, the minimum wage. The argument always put forward is that without a minimum wage, wages would be pushed to zero and workers would work in slave-like conditions.
This argument is false and is made without any evidence. Because there is no evidence.
Providing you have a free society where people are not compelled to work against their will then it’s not possible for wages to fall to zero.
Contrary to conventional wisdom, it’s actually only in economies where there is an interfering and coercive government (by nature all governments are coercive of course) that real wages are forced lower and slave-like conditions exist.
And unlike the claims made by the zero-wagists, there is plenty of evidence to support our argument. Just look at any tin-pot dictatorship, or even at any western democracy for that fact.
Government’s favourite way of doing this is through inflation. We won’t get sidetracked, but take this revelation from the Herald Sun:
“Australians have to work almost three times harder to pay off the average family home than they did 50 years ago… homebuyers on the average income now have to work for 19,374 hours to buy the average Australian house with the average mortgage… In 1960, it took homebuyers just 7500 hours to pay off the average mortgage.”
Take into account other increases in the cost of living and the devaluation of your money, it’s no wonder the quality of life hasn’t improved.
Anyway, it’s important to remember that wages is just another term for the price of labour. You sell your labour to an employer for a price (wage) that you’re willing to accept. And the employer will pay for your labour (a wage) at a price which he or she believes is acceptable and profitable.
As we’ve mentioned before, the impost of a minimum wage distorts this pricing action and leads to employers finding alternative ways of employing people.
Either they will look for new technology that can replace the work of individuals, or they will send work offshore where the price of labour may be cheaper. Or they may even use legal or illegal imported labour where different working conditions may apply.
The point to remember on the use of cheaper imported or exported labour is that the claim about cheap labour from overseas ‘stealing’ the jobs of Australians isn’t true. In reality it’s market manipulation by governments, bureaucrats and trade unions which is responsible for unemployment.
In most cases jobs aren’t actually being taken from Australians at all. Because either the job in Australia doesn’t exist at the price the employer is willing to pay and the employee is able to accept, or it’s no longer profitable for the work to be done here due – in part – to minimum wages and other labour restrictions. Therefore the job would disappear anyway.
If it wasn’t profitable for the employer to offer the job at the minimum wage level, and the job couldn’t be sourced from overseas labour then the employer wouldn’t create the job anywhere – it wouldn’t exist.
Even in the case where an employee loses a job in Australia, and a new job is created overseas to carry out the same tasks, the job isn’t being ‘stolen’, but rather it’s due to the inability of the employer to source the job locally at a profitable price of labour.
If it wasn’t profitable for the company to keep employing an Australian at the higher rate, and they couldn’t source the work cheaper overseas then eventually the Australian would lose their job anyway.
Businesses go bust all the time for that very reason.
Let me illustrate it to show you what I mean…
Let’s say a job is only profitable for an employer if he or she can pay someone $8 an hour. However, the minimum wage law insists that the minimum pay is $10 an hour.
Therefore the employer will not create a job to pay someone $10 an hour when he or she knows they will make a loss. In this case no job can be created and therefore there is no job for an Australian at a rate of $10 an hour.
But then let’s assume that the employer finds a job market overseas that will allow him or her to pay workers $7.50 an hour. And assume it costs 50 cents an hour for the completed work to be imported back to Australia, the employer is able to make a profit on the production of the product.
Therefore, due to the lower rate of pay in the overseas employment market, a job has been created at a total cost of $8 an hour.
But remember, this isn’t a job that has been ‘stolen’ from an Australian worker, because at $8 an hour the job doesn’t exist in Australia.
And as we note, even if it’s an existing industry, if the minimum wage rate was unprofitable for the employer, the job would have disappeared in Australia anyway even if it wasn’t replaced by an overseas worker.
In other words, it’s the artificial setting of wage rates that causes job losses not overseas workers who are prepared to accept a lower wage.
But let’s put it another way. Let’s forget about minimum wage levels. Let’s look at higher pay scales where you’ll see that the same principle applies…
If we consider there’s someone applying for a job as a hat salesperson that pays $100,000 a year. But this person has no qualifications or experience as a hat salesperson. However, the employer takes a shine to them.
The employer likes the fact that the applicant has previous sales experience and believes that the ins and outs of the millinery trade can be easily taught.
However, the $100,000 wage was aimed at someone with hat sales experience, so the employer offers to pay the unqualified applicant a wage of $80,000.
What does the applicant do? They would prefer a wage of $100,000, but in the opinion of the employer the applicant is not worth that amount. The applicant is only worth around $80,000.
The applicant has two choices, he or she can either decline the job offer and hold out for a higher paying job elsewhere, or they can accept the lower pay. In this instance the applicant accepts the lower pay and a job is created.
But now consider what would happen if the government imposed a minimum wage level of $100,000 for all hat salespeople. Naturally, those in the industry would be delighted, “It’s a bumper pay day” they would yell.
As we pointed out yesterday, it would be a bumper pay day for some, but not for all. In the instance of our applicant above, it would not be a bumper pay day. Because as much as the employer may like the applicant, he or she would only employ them if they could pay the applicant $80,000.
But under the law they could not. And worse still, even if the applicant is prepared to accept a lower wage the law decrees they cannot accept it.
In this instance no job is created.
Now, I’m sure you’d agree that an artificial minimum wage for a middle class job would be terrible for many in the middle class. It would make their job prospects much tougher and would either force then into trying to apply for higher paid jobs for which they may not be qualified, or it could force them to take work in a lower paid job which they did not really want or were not suited for.
Or it may mean they are left without a job.
If you accept the logic that an artificial minimum wage would be terrible for the middle classes, then logically you have to accept that current minimum wage laws are equally bad for those on low pay.
If we return to our point above about wages being another term for the price of labour, then you’ll see that wages would not go to zero if there wasn’t a minimum wage. To claim it would happen is brazen misinformation.
In fact, if you accept the arguments above, then a minimum wage may not have any impact on the wage rates of existing jobs at all. In the case where jobs are not currently in existence due to minimum wage laws, new jobs would be created onshore rather than overseas, and it would be up to employees to decide whether they accept the wages offered.
If the wages offered are too low then employers will not attract a workforce. Especially if there are competitors in the new industry as competing firms would increase wages to a level that would attract workers.
Naturally, if workers are still not prepared to work at a level which the employer deems to be profitable then there will be no job creation. The point is that the market and individuals will have decided that, not an arbitrary decision from a jumped-up bureaucrat.
However, in some instances the abolition of the minimum wage could lead to lower wages. Yet, it should be remembered that those higher wages were only available to those lucky enough to benefit from an artificially set wage – this is how trade unions work.
For instance, if an employer has a total wage budget of $500,000 per year and the minimum wage is $100,000 each, then he or she can only employ five people.
Yet, if there is no minimum wage the employer can either maintain the current staff on their wages, or if he or she believes there would be an increase in productivity and profits with six employees then there would be an incentive for the employer to drop salaries to $83,333 each.
Or offer varying salaries above or below the old minimum wage based on performance.
In that case the employees would need to decide whether they are willing to accept this or not. And if not, find alternative employment.
The point is, the example above is merely the opposite to what happens when you have trade unions and governments manipulating wages policies.
Increases in wages that are determined by governments will necessarily lead to losses in jobs. There’s no avoiding it. It applies whether you’re looking at manipulating the high end of the job market, the middle, or the low end.
The reverse is that the abolition of artificial wage levels such as the minimum wage creates jobs. That’s real jobs, not the type of job the government creates by paying people to install insulation and then paying a bunch of other people to rip it out again!
Cheers.
Kris.
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etch – exactly what money are you talking about. please reference it or provide a link.
pf- its our 4 major banks they have in loans,cd’s,deriverates etc i’m sure cb will know bout em
PF – I cannot give you a specific reference, but Sayce has written about it before, and I have seen it referenced elsewhere, probably to the RBA’s website, that the big 4 have some 13T worth of assets off balance sheet. The question is, what are these made up of, and what are they really worth?
13trill$ of smok”n”mirror
The silence of the lamb …
This is the worry, and what should keep us up awake at night. If I understand it right, shareholder equity is less than 1% in value of the offbalance sheet assets of Australian banks. Talk about living on the edge.
Bomb ticking for off-balance banks
http://www.theaustralian.com.au/news/bomb-ticking-for-off-balance-banks/story-e6frg7f6-1111115574495
So, the question is: When these assets go pear shaped, who will be tapped for saving our banks? My guess: You and I. And yours?
etch – do you mean the loans (listed as assets in tables 1 and loans in table 2. Deposits are listed as liabilities in table 3.
I don’t know what the article (that cb referred to) means in relation to off balance sheet assets. I really can’t enlighten you on that, but these matters are strictly controlled so I wouldn’t panic.
cb @ 113, A loan book is worth the sum of every loan in the book. We have an arrears default rate of about 0.6% I believe so the odds are the value of the book is at a premium, not a discount.
yes PF -dont panic,just hold on tight ,grease is the word
i’m worried bout me savings in these “PONZI-TUTIONS”
* Adele Ferguson * From: The Australian* February 18, 2008 12:00
A TICKING bomb for the banking sector is its off-balance sheet activities, which at last count stood at $12.9 trillion.
Australian banks have a big exposure to derivative markets. Their total shareholder value of $110 billion is dwarfed by the size of the banks’ collective exposure to derivative markets of $12.9 trillion.
Put simply, the total derivative positions of the banks are 117 times as big as the banks’ shareholder value. If even 1 per cent of these derivatives contracts default because third parties at the other end get into trouble, the whole shareholder wealth would be wiped out and our banks could be broke.
Given total bank assets are $2.1 trillion, it begs the question why Australia’s banks have exposure to $12.9 trillion of derivatives positions. All banks hedge to reduce risk, but this is a big amount of hedging.
For example, Westpac has a face value of $1.4 trillion in derivatives at September 30, 2007, compared with an equity base of $16 billion, which is a multiple of almost 100 times.
The banks will argue they have outstanding risk management procedures and derivative arrangements have offsets so that only a net amount is at risk. Indeed, the Reserve Bank estimates that at September 30, 2007, the total credit risk and exposure of the banks to off-balance-sheet activity is $140 billion.
A more cynical observer would say the acquiescence of bank regulators to banks running off-balance-sheet liabilities greater than their capital just adds another layer of gearing.
But the reality is most are too big to be allowed to fail and wipe out their shareholders’ funds. Banks worldwide are in a favoured position. While most are listed entities, they can always count on the shareholders being underwritten by the taxpayer in a crunch. The most recent examples of this were Northern Bank in Britain, which reportedly had about €25 billion ($54 billion) pumped in by the Bank of England, and Societie General attracted immediate support from the French Government. In the US, the Federal Reserve has been helping out its commercial and investment banks.
There is no denying that the banks have slick risk-management systems and, as long as there are no defaults, everything will keep on humming.
But the potential magnitude of the problem becomes even greater as the banks dominate the debt and equity of the country through their dominance of funds management.
As one investor said: “Do the bank balance sheets show a true picture? Well that’s not what they are for. They are basically a disclaimer exercise.”
But turning from the off-balance sheet world, to the on-balance sheet world, including the stock market, Australian banks have taken a walloping, none more than NAB, which is now trading at the same level it was nine years ago when the bank was concerned it was a sitting duck to foreign predators.
Apart from hedge funds targeting the banks, investors are becoming increasingly uneasy at the exposures the banks will have to corporate failures.
The reality is that as the sub-prime mortgage crisis continues to unwind, more corporate defaults will take place. While, on average, Australian corporations are in better shape, in terms of profitability and gearing, there is a group of financially engineered companies with low profitability that have piled up a mass of junk bond debt that will soon come to refinancing at much higher spreads. And as monoline insurers look wobbly, this will add to the difficulty in getting a refinancing package.
Already companies such as Centro, MFS and RAMS Home Loans have suffered the plight or tough credit markets. Others are sure to follow.
NAB has the largest market share in commercial lending and the second-highest transaction banking market share, which makes it a strong candidate for having the riskiest loan book with regard to Australian commercial lending.
However, an analysis by Wilson HTM of listed companies that have lost more than 20 per cent and more than 50 per cent of their market capitalisation in the past year, NAB may have the lowest exposure of all the banks to poorly performing companies when ranked by debt outstanding.
In the case of the Commonwealth Bank, its profit results epitomised some of the challenges facing the banking sector in Australia: rising expenses, rising cost of debt and murky bad and doubtful debt exposure.
Commonwealth Bank’s latest results revealed bad and doubtful debt charges rose 40 per cent from the first half and a 71 per cent increase from the previous corresponding period.
Reported gross impaired assets were up 66 per cent from $338 million at December 31, 2006 to $562 million at December 31, 2007.
New and increased impaired assets were $566million at the end of December 31, 167 per cent of gross impaired assets at December 31, 2006.
Given the statements by the Reserve Bank suggesting at least two further rate rises in Australia, this will put a great deal of pressure on the many highly geared consumers and lead to an increase in loan defaults. As a consequence, many analysts are increasing their bad and doubtful debt charges in the retail banking sector both this year and next year.
UBS put together a watch-list of potential problem loans, including Centro, Countrywide Financial, MFS, Allco and Allco Principals Trust, to which they have lent a collective $5.7 billion. It suggests that Centro has a $500 million unsecured loan and $700 million secured loan with ANZ, a $160 million unsecured loan and $1 billion secured loan with the Commonwealth Bank and a $350 million unsecured loan and $750 million secured loan with NAB.
The other big risk is Countrywide, which has a $150million loan with ANZ, $300 million loan with Commonwealth Bank, $300 million loan with NAB and $100 million loan with Westpac.
There is little doubt banks have undertaken extended value-destroying lending, based on declining underwriting standards. But as the cost of debt increases and the shake-out in credit markets triggers concern about losses in syndicates or companies involving the banks, including ANZ’s exposure to Lance Rosenberg’s embattled broking house Tricom, it is premature to discuss systemic issues.
But for banks, with expanding funding cost pressures, and Commonwealth Bank’s results showing a blowout in expenses, most banks will start initiating cost-saving programs. As Wilson HTM analyst Brett Le Mesurier says: “Expense growth is a problem with salaries increasing by 12 per cent over the year, which was the major factor in the high rate of expense growth during the period. This latter feature occurred notwithstanding the refund of $64 million from the Australian Government from over payments of GST.”
For the next couple of years, there is little doubt that the banks will face some challenging times, particularly if some of their off-market activities start to look wobbly. Let’s hope they have a good handle on it.
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