Do wage increases lead to greater inequality?

Early in the 20th century an English writer said “Life is the art of drawing sufficient conclusions from insufficient premises.”

Good data is supposed to limit the guesswork, but if our reasoning is wrong, our conclusions will be less than sufficient even if the premises are good.

The Gini coefficient which measures inequality is one of the most misunderstood numbers around today and so are terms such as inequality and poverty. Even the phrase ‘unemployment rate’ is so full of terms and conditions a second hand car salesman would be proud!

It is often said that South Africa has a very high unemployment rate and one of the highest (worst) Gini coefficients in the world. This is true, but not in the way most people say.

Yes, the Gini in South Africa is high! But data from both the National Treasury and Stellenbosch University show that when based on income only, the Gini in South Africa is 0.69, but when social grants, education and health are taken into account this number drops to 0.52.

This still leaves out free electricity and water allocations by municipalities. According to a KZN university report, these free services alone could bring the Gini coefficient down by another 0.04.

Taking tax into account, the highly progressive nature of our tax system takes the 0.52 Gini down to 0.47, which would put South African income distribution at levels close to those of the United Kingdom and the USA.

That gives us the first clue as to the nature of the numbers: most of the inequality in South Africa comes from the poorest people not getting enough income.

Taking income away from the rich doesn’t change much, so the solution has to be increasing income to the poor.

At this point we could all agree and move on, but we need to find out what this poverty thing is.

Based on a sample of more than a million people (one sixth of the formal private sector) PWC South Africa recently calculated that the Gini coefficient among people in private sector formal employment was 0.44.This does not take into account social benefits or taxes.

The estimate for the Gini coefficient among government employees is less than 0.35 before tax.

Both these figures reveal something important, which many commentators do not understand. Income inequality in South Africa comes mainly from the lack of employment, not from wage levels or pay gaps in the formal sector.

If we looked only at the small formal sector, taking into account tax and social spending on people in this sector,the Gini coefficient would be well below 0.4, and perhaps even as low as 0.28 which would bring us close to Germany or Norway, some of the more equal countries around.

Of course we do not live in that world, but the point is the major cause of inequality is not the pay gap, but rather the low number of people earning wage income.

That unemployment and wage increases in the formal sector add to inequality has been confirmed by UCT research in 1996 research by M Leibbrandt., C D Woolard, and I Woolard of the University of Cape Town’s Southern Africa Labour and Development Research Unit. They found that the Gini coefficient increased with wage increases, whereas increased remittances and welfare payments resulted in a decline in the Gini coefficient.

So unemployment is the major reason for inequality. How the heck do we deal with it?

World Bank data show South Africa has the 11th lowest participation rate in the world. Only 60% of South African men either want to work or do work.The actual male population employed is third lowest according to ILO data.

I use male employment data because, for cultural and religious reasons, many countries have low female participation rates and male rates give a better “want to work” overview.

Less than half of all working age men in South Africa work. Part of the reason for this is skill levels - about 61% of the labour force is unskilled - and education must play a big role in any solution. Education is also a big driver of earnings.

But a question must also be why so few people want to work. In the typical high-middle income country, 76% of all men participate in the labour force. That 16% difference can make huge inroads into income inequality - probably more than tax increases or making state expenditure more efficient.

Another reason for high inequality is the huge number of single parent households. South Africa has the highest percentage of single-female-headed households in the world and these households are more likely to struggle. Nearly half our children live in single women headed households, double the next highest country, according to the Luxembourg Income study which is the largest such dataset in the world.

So demands for ever increasing wages from militant labour organisations, making employment creation expensive and therefore less likely, would actually increase inequality in South Africa!

Yes we are an unequal country. But we are more equal when we work, particularly when we have a formal sector job. Fewer than 3 out of ten adults work in the formal sector.

In a country with so few people in work, and specifically in formal work, it is an error to think that equality will increase if we pay those in formal sector jobs more!

In the bigger picture of SA and the world , those in the formal sector are among the lucky few.

As UBS bank reports of earnings and spending around the world have pointed out since the 1970s, South African workers get paid in purchasing power parity terms better than workers in Athens or Rome. Not New York or London but certainly more than 90% of developing cities and quite a few developed ones too.

When a miner clears more than a teacher and we look at the poor performance of our education system, which we know drives earning potential and therefore inequality, we must ask if we are not fighting on the wrong battle front.

This false use of the Gini is a serious mistake. The war on poverty will not be won with the wrong strategy.

Mike Schussler is an economist at Economists dotcoza.

See also: Lessons from the platinum strike: the poison of inequality by Gilad Isaacs.