3200: Background and consequences of "governmental unexpectedness"

The Government of Volodymyr Groysman, speaking of a radical initiative of doubling of the normative of minimum wage already from January 1, 2017 (i.e. in two months), unexpectedly broke stereotypes of the vast majority of analysts, who in one voice assured that we shouldn’t expect surprises and breakthroughs from him. If to trust Leszek Balcerowicz, the decision was unexpected and for a group of foreign advisers and international organizations. Tired of the prolonged lack of money, ordinary laborers incredulously recount at how many times their welfare will grow now and wait for any dirty tricks from the government.

Expert community, which was caught with this “salary revolution” suddenly, tries to overcome the cognitive dissonance, sorting out mutually exclusive postulates of Keynesians and neoclassical on macroeconomic impact from increasing aggregate demand and hastily remembering on what else, apart from the pockets of workers, mentioned social standard influences. Opposition-minded politicians of all stripes, feeling the loss of familiar ground underfoot, ably maintain a wave of distrust in the good actions of the government, while trying to jump into a “train”, launched by it, with their populist bags. None of the approaches are constructive, since the idea of “3200” is quite radical to attract necessarily other changes that will follow her, and that are likely that they will destroy all the forecast constructions.

What motivated «
the revolution»: versions

To determine the forecasts of the likely future developments, let's first discuss some versions of the real motives underlying the “salary revolution”.

The first version is the Keynesian.
We can assume that the government decided to go by the followers of D.M. Keynes, seeking to accelerate economic growth by increasing domestic demand. This is possible, because, other things being equal, an increase in incomes of low-income categories of the population really is a good stimulator, because these consumer groups are mainly oriented on the domestic junk (which is beneficial to domestic producers) and cheap Chinese junk (which reduces pressure from the growth of incomes on the balance of payments). However, such an interpretation of stimulants for economic growth is somewhat superficial. Yet, Keynes considered the economic growth in close connection of incomes with employment levels and interest rates. In the case of Ukraine, monetary-credit policy is counterproductive to growth, and the labor market is practically not correlated with economic dynamics. The Groysman’s idea does not look like as the idea of “helicopter money”, periodically discussed in expert circles, because the latter directly develops the theme of monetary “quantitative easing”, which is not being discussed in Ukraine now. Therefore, the version is seeming unlikely. The Prime Minister, the President and the National Bank are tending to the neoclassical model of tight monetary policy and promise to the International Monetary Fund to carry out it, and they never demonstrated the capability to be “baptized” in other theoretical “faith”.

The second version is a political-populist.
The idea of “3200” is very “nice” for a significant number of workers, who actually receive funds, close to the minimum wage (or less, compelled working on a part-time rate). Even the fact that someone, who has officially only the minimal wage, receives real wages “in envelopes” should not obstruct a real problem of unacceptable poverty of a very significant number of employees. Therefore, an increase of incomes of low-incomes categories though a targeted manner will have some positive effect, which is now especially needed, when society will discuss increases of MPs’ wages and published property declarations of civil servants. In the clear majority, people do not believe on populist promises, and increasing own salary even by half will receipt only as a promotion for its improper comparison with the income of employees of ministries or state corporations. It is proved that the electoral effect of raising the average income is very low since the representatives of small, medium and large businesses that affected with this increasing, actively influence on the formation of voter sentiment.

We note that all a long time already accustomed to the fact that the idea of increasing people's well-being the best resorting to authorities for the closeness of elections. Therefore, if the launched version is true, the reasoning developed toward the “conspiratorial” version: that, despite the lack of official decisions, and even active political discussions in this regard, the issue of early elections of Spring 2017 have decided, and (unlike from era of “the great confrontation” of 2007-2008) the President and the Premier are the consistent fronts. Currently, it is not even important will be the decision to hold elections initiative (by the authorities) or reactive (as a concession to the protests inspired by the opposition), the current government is trying to make proactive electoral “reserve”. However, if support the opinion of some political analysts that publication of e-declaration “has led to zero” electoral chances almost of all politicians, which made the idea of early elections unattractive, we can assume that the government probably wants to create a “safety cushion” against the expected social protests. Then conspiracy is that the radicalism of idea put forward by the government suggests the high probability of those events, on which an advance is carried out.

The third version is the political-pragmatic.
Now it seems the most likely. The point is that the minimum wage is one of the few options that is specified in the budget in an explicit form. And if the vast majority of indicators used in the calculation of income and expenditure parts of the budget are forecasted, that is almost exogenous for the government, the minimum wage is set almost volitionally. If the government exhausted the possibilities of expenditures expansion within existing budget constraints, but for some reason cannot refuse to the pressure of some of these groups (see also the “conspiracy” version), it may try to vary this macroeconomic option to expand the room for maneuver in the calculations, while remaining within the defined framework of deficit. The minimum wage is a very convenient indicator for this since it is setting a number of parallel effects. Firstly, it directly increasing budget revenues (by increasing the tax on individual income). Secondly, it increasing revenues of the Pension Fund and reduces the need for its deficit subsidizing. Thirdly, it allows for saving on housing and utility subsidies by increasing revenue and raising the threshold of their provision. From the level of the minimum wage are calculating some taxes (on real estate and a single) and fines. However, according to the statement by officials, salary increases is not accompanied by an increase in taxes, therefore, they must be “unlinked” of this standard. Instead, funds for the salary increase are planned to receive from the deshadowing of employment, although the government also acknowledged that the specific budget transfers under the new social standard have not yet been carried out.

The budget, recalculated in this way, on formal features could be well sustained by the International Monetary Fund, which is beginning its consideration of granting Ukraine the next tranche. Whatever Leszek Balcerowicz may say, but to assume that the government could resort to “salary Revolution” in a period without the support of the Fund is virtually impossible.

Possible scenarios of further developments

The only one, but a significant problem remains. It is a reaction of the real economy on increasing of the minimum wage indicator. And it will directly depend on how this increasing will be practically implemented. In this context, we can assume several scenarios.

The first one is a “victory”. Increasing is actually increases the purchasing power of the population. The domestic business quickly responds to demand, contributing to economic growth, employment growth, structural modernization with increased focus on the domestic market. Budget revenue growing, which allows properly fund increase of salaries in the budget sector. De-shadowing of employment in the private sector brings an additional income to the Pension Fund, so becomes possible to gradually “pull up” pensions’ sizes. However, too many additional conditions should be implemented for such a successful pattern. Namely – to be able to direct additional (not reallocated) financial resource to increase the labor remuneration fund in the budget sector to cover the lag to hypothetical revenues from de-shadowing. To provide financial opportunities for entrepreneurs to react quickly to the growth of demand (working capital) and to keep the markets in the medium and long term perspective (“long money”). To increase the flexibility of the labor market: if the raising of the minimal wage makes it more regulated, it must be compensated with simplification of firing and mobility of labor forces. To keep a high level of trust in the government and take additional measures to make possible the expected de-shadowing. An operation of the whole complex of these conditions in the first quarter of next year seems to be impossible because the scenario is rather fantastic.

The second one is a “money into the sand”. The increase of social standards is due to the reallocation of budget funds from other articles for labor remuneration, especially – the development expenditures. The increase of wages in the private sector increases the labor costs for business, which is transferred to the cost and price of products and accelerating inflation, which “eats” a significant part of the increase of purchasing power. Economic growth remains very frail because of the inability of easing an access of companies to financial resources due to the high inflationary threat. High demand increases imports and worsens the trade balance, which puts pressure on the devaluation of hryvnia. Finally, an increase in wages has a fading effect and causing another wave of destabilization. The scenario seems very likely, but it may not be true because it requires changes in the “body” of the budget that may be unacceptable to the IMF, as well as for some interested economic groups.

The third one is a “zilch”. Increasing social standards is not accompanied by an increase in labor remuneration fund in the budget sphere, that is carried out by income redistribution within the budgetary institutions and reduce the number of employees. The budget further strengthened because of restrictions accessing to subsidies (still an implicative income for the unemployed amounted two minimum wages). Foreseen development expenditures are kept in the budget, but in the private sector, a tough anti-inflationary policy that prevents to compensate the rising cost of labor also raises the necessity of reducing employment. Thus, in general, an increase of social standards is not accompanied by a noticeable increase in the aggregate consumer demand and is not an effective engine of economic growth. The growth is achieved mainly by improving external conjuncture, which works as a factor of structural modernization of the economy to meet the needs for fixing the export-oriented growth model. Under present conditions, such a scenario should be considered as a basic.

The fourth one is a “betrayal”. Highly optimistic expectations on the costs from the de-shadowing and overstated indicators of budget income and expenditure “tear” the implementation of budget obligations of the state. To avoid the burst of social tensions the government had to resort to a deficit monetization. This accelerates inflation and fails based on negative expectations hryvnia’s rate. The IMF broke off relations with Ukraine, which results in capital outflows and increased monetary and exchange rate instability. Reduction of employment additionally worsens a negative inflation-devaluation effect. The only engine of growth remains the export-oriented sector, stimulated with devaluation, which increases the structural disparity of the economy. Luckily, this negative scenario is also unlikely due to the rather strict liability in fiscal and monetary policy to foreign creditors, cooperation with which remains no alternative because of the high external debt obligations.

The main risks: about what the government should remember?

On the choice of the case scenario of further developments also will affect the way in which will be considered and compensated the main risks associated with the announced plans of the government. We emphasize that some of the risks are starting to act now when these plans have not even get the subject measurement. The inflationary effect of raising the minimum wage will work the most expeditiously. Price formation on agrarian products for the winter-spring season is currently undergoing, which should ensure the proper storage of financial resources to the spring field work. The “Salary Revolution” definitely will increase inflation expectations of market participants. Especially that it coincided with the “experiment” on the abolition of state regulation of prices. Experts agreed with the fact that this abolition doesn’t promise an inflation burst because of the limitation of consumer-capable demand for basic goods. Since January 2017 the situation will change, and the inflation expectations will work with traditional prejudice. Devaluation expectations will be formed similarly. The power of this risk increases with announced by the National Bank rate at the introduction of inflation targeting. An inflationary “overheating”, generated by expectations will be extinguished by monetary restrictions that are murderous for tendencies of growth. Therefore, to return to the constructive scenario, it must be admitted that some acceleration of inflation is inevitable, and this should be taken into account in terms of forecast indexes of the Budget-2017 and inflation landmarks of the NBU.

“The generosity” of the government unblocked the populist trend in domestic politics chastened by crisis and war. A wave of requirements for increased social spending is growing, and additionally feeding with published e-declarations, after which the usage of the term “belt-tightening” will be inconvenient to a vast majority of politicians. Having opened this “chest of Pandora” the government must have the political will to stop in time, working out the budget for 2017, and, most importantly, to stop massive desire “to share everything”, the more that this “everything” got a specific cost and property measurement in declarations.

Sharply increasing conventionality of getting budget revenues for the next year. If earlier experts were worried about the uncertain 10 billion UAH from the special confiscations, which were planned to direct for development goals, currently the amount is planned to get the budgets and the Pension Fund from the hypothetical de-shadowing, is much larger, as the social cost of a possible shortfall. A conservative scenario for the expected additional revenues can be a certain fuse, and the Budget Law can determine where will be directed additionally received funds if any. By the way, if not the promise of doubling the income of low-income workers since January, the government could offer an inclusive formula of phased increase of the minimum wage during a year, which depends on the additional revenues.

The greatest risk from the raising the minimum wage rate is subjected to employment rate. Having received no additional resources, employer – whether private or budgetary institution – will have no choice but to fire workers. We think that a trend of enhancing employment shadowing will prevail too. Intersectoral modulations of workers are possible, in particular – skilled workers from the public sector, which bonuses will be canceled to fund salaries of less qualified personnel. Obviously, the government should prepare for the burst of unemployment and offer an alternative to employment, in particular – in small businesses. Regarding the public sector, the best would be for the state “to set an example”, adequately increasing the labor remuneration funds of budgetary institutions.

Instead of an epilog

In fact, increasing incomes of employees is not just the trend of the time, but a necessary condition achieving consistently high dynamics of economic and social development, catch critically growing backlog in the quality of life from the nearest European neighbors. But this should be done by creating conditions to generate resources by economic, aiming to increase wages. Contributing the growth and diversification of exports, building the financial base of “long” money for investment in restructuring, strengthening market infrastructure, developing small businesses and entrepreneurship, conducting competition policy. But the government has traditionally followed through administrative establishing a new framework for business, not taking care of the problems of its compliance. Because to make decisions is always much easier than to achieve results.