Labor Welfare and the Law of Supply and Demand

By webadmin on 08:59 am May 04, 2012
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Pramudya A Oktavinanda

Labor welfare and how capitalism abuses laborers is always a controversial issue. Some people argue that capitalism has destroyed the quality of laborers’ lives, all for the sake of maximizing profit. But is this correct? Does a free market economy impose a significant burden on laborers? My answer is no and we can explain this problem through the lens of supply and demand.

The basic economic concept that we must understand here is that whenever the supply of a product  rises but demand is stagnant or cannot follow  supply, prices tend to fall. The reason is simple: If we have an oversupply of products in a market while demand is at a minimum, the seller will be pushed to reduce prices in order to induce more buyers to purchase the products. A similar thing is happening in Indonesia when we talk about the supply of laborers, especially blue-collar workers with low levels of education.

Consider this: Indonesia is the fourth-largest country in the world in terms of population. From such a large population, how many people have had the opportunity to finish their education? How many industries can absorb a huge number of workers? Theoretically, if the number of labor-intensive industries is not big enough, assuming a huge supply of blue-collar workers, then salaries will be low. 

From the perspective of industry, why bother paying laborers more when it is easier to replace them with others eager for the opportunity to work. This works for all industries. Consider the example of lawyers who want to work in big corporate law firms. This job offers a lot of compensation (of course, in accordance with the difficulty and intensity of the work).

How could that happen? First, resources for high-quality lawyers are limited. Second, there is a lot of competition between big law firms to land and retain the best talent. Since demand is high and supply limited, we can conclude that the price of the product, i.e. the salary of corporate lawyers, will increase substantially.

Now we turn to the main problem in this article. How can we increase the welfare of laborers? Short-term solutions have already been carried out in Indonesia through labor regulations. We have minimum wage laws and our laborers are quite protected in the sense that companies cannot easily fire their employees. This limits companies in their ability to quickly turn over their work force and forces them to invest more in existing workers.

But such policies are not without consequences. That there are minimum wages and job protection is good for people who have secured a job. For people who have not secured a job, these so-called protections are problematic. Establishing a minimum wage might put a strain on businesses’ budgets, forcing them to take on fewer employees. Furthermore, since they cannot easily fire a worker and find a replacement, they have more incentive to ensure that the current employees stay with them, decreasing the level of new hires.

That is why we need a long-term policy that will work for the future. There are two ways to effect the price of a product. We can adjust the demand side, or we can adjust the supply side. In terms of supply, it is imperative that we pursue a policy of effective birth control. Like it or not, birth control is very important. If we talk about mere products, we can simply put the excess products in a warehouse, but we can’t do that with human beings.

Another thing that can be done is of course to invest more in human resources, increasing the education level of the population, with the hope that this policy will reduce the number of cheap laborers in the long run. I will not discuss the best way to increase investment in human resources and how to finance educational policies as I have written about that in the past. 

As from the demand side, we can try to give more incentive to entrepreneurs and capital owners to invest in labor-intensive industries (at least in the short run). This brings us to the idea that the government should invest more in building infrastructure and reduce the costs of doing business in Indonesia. Through this policy, we hope that the level of demand can be increased to absorb the laborers up to a level where companies are competing to get talented workers. As I discussed in the case of corporate lawyers, competition will be beneficial for laborers, but this will not happen if education levels are low and industries are not big enough.

I believe that the most efficient way to improve the welfare of laborers is through the free market process. The government can surely help us in achieving that goal, but in order to do so, it should use correct methods and policies. Asking companies to pay more without any justification is simply a bad idea. It gives the wrong incentives and we cannot expect that such a policy would actually improve society in the long run. Instead, we should pursue a policy that will work well with the law of supply and demand. 

The final question is: What will we choose?