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On May 1, Prime Minister and Finance Minister Anwar Ibrahim made a dramatic statement to a group of civil servants in Putrajaya.
(FMT) – Starting in December, civil servants will receive an unprecedented 13% salary increase.
That sparked a flurry of criticism that such pay increases would lead to inflation, widen budget deficits and lead to inefficiencies.
The pay hike, which came as Pakatan Harapan convincingly won civil service and police votes in the recent Kuala Kumau by-election, drew criticism that the move was just a cheap political ploy to win votes.
There is no doubt that Anwar’s salary increase announcement is the largest in recent civil service history.
About 31% of government operating expenditures are spent on civil servant salaries.
This will increase public debt, which currently stands at RM1.19 trillion, depending on which set of numbers you look at.
However, a pay rise for civil servants will put money directly into the hands of consumers at the end of the year, keeping the economy resilient through strong domestic demand.
This is the most effective and efficient way for the government to prevent private consumption from stagnating in the near future. In December 2023, private consumption accounted for 59.1% of GDP.
The level of private consumption is critical to Malaysia’s future GDP growth. From this point of view, an increase of RM10 billion in public debt may lead to greater growth in private consumption through a multiplier effect.
Salary increase is an effective driving force for wage growth
For years, economists have argued that wage growth across the economy has failed to keep pace with GDP growth.
As a result, wages have actually fallen over time, which means that working people have missed out on a growing share of the economy’s prosperity.
The salary increase affects not only government officials in various ministries, but also medical staff in government hospitals, teachers, public university staff and military personnel, totaling about 1.7 million people.
This represents just over 10% of Malaysia’s total labor force of 16 million.
Under the constitution, the government has no control over wages, except in the public sector.
Any government decree to raise wages for private sector workers cannot be enforced. Therefore, by raising public sector wages, Anwar is sending a signal to the private sector to raise wages to maintain parity with wages within the public sector.
There are already positive signs that this strategy is affecting other wage payers. The Sarawak government, for example, has announced that it will consider following suit.
The government hopes that Malaysia’s corporate sector will follow suit. If blue-chip GLCs follow the government’s lead, other private sectors will also face pressure to raise wages.
Those wage increases would then trickle down to other workers in the economy.
Any increase in state wages would be a great reform.
What could possibly go wrong?
Forcing national wages to rise through public services is not new. It is a well-known fiscal tool used by governments for more than 70 years. Experience shows that directly raising wages without increasing productivity can lead to dangerous inflation.
Given that productivity is simply a calculation of output measured in ringgit against input also measured in ringgit, there are many ways to achieve productivity improvements.
The first is to improve internal efficiency. This involves organizational change. Operating costs can be controlled by utilizing zero-based budgeting and project-based budgeting.
Another approach might be to maintain employment caps to stop the bureaucracy from swelling. Another way to boost productivity is to increase the cost of government services to households. Some mix of the above works best.
This will be even more important in the private sector. There is a lot of talk about the use of artificial BroadCast Unitedligence in business, and this is quickly being reflected in banking systems that are going digital.
Artificial BroadCast Unitedligence can also be applied to education and service industries. However, a side effect of AI will be job redundancy, which will lead to greater unemployment unless new types of jobs can be found for those affected.
The trickle-down effect of public sector pay rises could affect other parts of the economy.
If wages in labor-intensive industries face upward pressure, then companies will have to make a choice. Those options could include hiring cheaper foreign labor or automating operations.
In both cases, this will displace local employees and increase unemployment. Higher wages will also burden “hand-to-mouth” SMEs where liquidity and/or available credit are very tight.
As a result, wage increases are likely to dampen private sector employment growth.
Salary increases must be part of a wider strategy, leveraging both macro and microeconomic initiatives.
The key to any pay rise is to achieve commensurate gains in productivity to offset the additional costs to the private sector. This is not easy to achieve.
Politically speaking, if the results of the Kuala Kubu by-election are replicated in future elections, the pay hike announcement appears to have paid off among public service voters.
Any costs won’t be apparent until 2025 or even 2026. In the short term, wage increases may lead to increased demand for consumer goods.
In the longer term, however, higher wages may lead to higher unemployment in the private sector unless productivity increases accordingly.
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