The fight is fighting, the war is waging war

“The fight is fighting, the war is waging war.”

José Toro Hardy

The regime’s chosen strategy is to raise the minimum wage by increasing it to Bs 65.056, with an additional food bonus. This objective was made clear by President Maduro, “The fight is fighting, the war is waging war.” What is lacking in this strategy however, are social and economic incentives.

No one can deny the need to increase workers’ income. The ultimate issue lies in that the objective of improving remunerations is to benefit the workers. However, is that what will actually be achieved or are we simply looking at another short term populist measure? Let’s see:

As occurs with any increase, companies respond in three different ways: The first is to adjust prices to cover the increase in labor costs, the second is to reduce staff, and the third is to try to offset costs by increasing productivity.  

Are companies able to increase prices to accommodate the cost of the increased minimum wage? In the current circumstances, the answer is that many cannot, as they are faced with price controls policies that impede them from doing so.

If they are unable to adjust prices, companies will be forced to reduce labor costs by reducing staff. Can they do it? The answer is no, as there is a decree on labor stability that prohibits them from doing so.

Companies will thus have to turn to the third alternative, seeking productivity gains by investing in capital goods, namely machinery and equipment. This means that they would need to replace staff with machinery, i.e. reducing staff. Yet, as we saw, labor stability decrees prevents them from doing so. Moreover, the cost of such machinery is inaccessible because they tend to be imported, and exchange controls limit the availability and access to the currency needs to do so.

Furthermore, increases in labor productivity are generally coupled with increases in product volume. But can companies even increase product volume given the current circumstances? The answer is most likely no, because in order to do so they need access to raw material and inputs that are not available in the country, and furthermore cannot be imported due to lack of currency as explained earlier.

With all options exhausted, the only alternative remaining for countless companies is to close their doors. In particular, there will be a massive closure of small and medium sized businesses.

In terms of the public sector, the consequence will be a growing fiscal deficit. In order to cover it, the regime will resort to BCV financing,  and thus considerably increasing the money supply by inorganic emissions of money. Result: hyperinflation.

Overall, the immediate consequences of the decree to raise the minimum wage will affect several sensitive areas of the economy and society in the following ways:

Firstly, there will be a significant impact on prices, meaning that in the upcoming months inflation will skyrocket to unprecedented levels.

Second, unemployment will grow exponentially.  

Third, as countless businesses close, shortages will worsen.

Fourth, the black market will expand, fueled not only by growing shortages, but also by the large number of workers without formal employment who will have to seek alternative means of making an income.

Fifth, the levels of suffering will be tremendous, as there is no worse situation for a family than that of unemployment in times of hyperinflation.  

All of the above is simply an oversimplified analysis. The decision to raise the minimum wage was made, presumably, with the intent to favor workers. Yet, within this decision, lie different ulterior motives.

It may simply be a populist response to the heavy loss in the regime’s popularity as they face a presidential recall.  This implies intentional deception of workers who are attracted to the simple idea of an increase in income and do not have the necessary resources to analyze the complex web of consequences that a measure like this can trigger.

Raising workers’ incomes is a highly desirable goal, yet only to the extent that the benefits outweigh the consequences.

A wage increase that does not correspond to increased productivity results in a more than proportional increase in prices. Inflation will quickly swallow any additional income and workers’ livelihoods will continue to deteriorate.

And after all the immediate impacts, are the more complex macroeconomic consequences. The measure will contribute to greater economic contraction, aggravating the already severe drop in GDP, which the IMF has estimated would decrease by 10%, and increasing inflation, which is predicted to be 720% in 2016. And certainly, it will impact the value of the bolivar, making imports even more expensive.