Forecasting wages in emerging markets over the next 5-10 years

Forecasting wages in emerging markets over the next 5-10 years

One month ago, I started a discussion “Which indicators can be used to forecast wages in emerging markets over the next 5-10 years” on our “FDIexecutive” LinkedIn group as well as the LinkedIn Group from the “Economist Intelligence Unit”. This issue came to the surface as ICA is currently involved in many corporate site selection projects in emerging countries where insights into future wage development is crucial for the final location decision making process. Professional input via social media outlets such as LinkedIn and Twitter on this significant issue related to Foreign Direct Investment (FDI) can only contribute to more insights.

As the discussion received considerable attention from LinkedIn members and the media, triggering more than 50 posts, ICA has summarized the main points of this issue below:

All participants to the discussion agreed that the development of wages in emerging in the next 5-10 years will obviously be shaped by macro-economic indicators, such as inflation, unemployment rate, domestic and foreign investments, governmental policy etc. However, in the end it boiled down to the fact that competition will drive wages up: Law of supply and demand.

Some members used theoretical approaches such as the gross fixed capital formation to labor intensity ratio in a domestic perspective and in an international perspective and the use of the Phillips curve with the inverse relationship between the rate of unemployment and the rate of inflation in an economy. The latter theory however is not observed in the long run. An interesting post was written by Jacque Vilet, who used her business background instead of an economist view. She stated that the improvement in the lives of people in emerging markets and the consequent increase in the middle classes with more disposable income led to a new vast customer base for products from the developed world. A similar strategy that Henry Ford envisioned when he set up his production cost strategy for the T-Ford model in the early 20th century. Henry Ford emphasized that if he would pay his workers well, they would also be able to buy his cars. To sell products in these markets, investments are made and labor is hired in these markets to win market share, which increases competition for labor and thus higher wages. This is supported by Guy Navon who stated that wages are determined by the demand and supply of labor hours in the economy and therefore relates to real GDP growth and labor supply indicators. Henry Loewendahl agreed and elaborated that demand is elastic (GDP growth) while supply (labor) is relatively inelastic as policies to significantly increase the labor supply are long term or longer than the investors’ business planning.

To determine the demand and supply of labor of an emerging market, Roger Botto mentioned that the point of departure is the initial level of life and future projects, i.e. endowments. Pedro Dudiuk contributes further to this statement by saying that future projects can be monitored by the movement of capital, international solvency and development of the internal market. Further considerations then are education and skills levels and workers outbound and inbound mobility, also addressed by Snehal Manjrekar. 

Another interesting aspect of wage forecasting in emerging markets was posted by Mahima Khanna, who suggested not to disregard the size or strength of the informal markets in emerging markets. As example she mentioned India where 80% of employment is in the informal sector which constitutes a significant wage determinant.

To sum up all contributions were very relevant and ranged from integrating macro economic and political fundamentals into the equation and modeling. However, strong industry effects remain relevant as well. In some industries wages tend to increase faster than in other. Similarly, multinational corporations also tend to pay higher wages and salaries. Finally, it is important to note that the existing level of FDI and the potential future absorptive capacity of new FDI projects in the same industry within a country is an important factor of future wage growth. Countries like China, with its vast labor reserves, have been able to much longer facilitate and host new FDI projects as the supply of new labor keeps wage levels stable. It is only since the last two years that China experiences wage increases in the Coastal Provinces within various industries. Other countries will reach their absorptive capacity at a much earlier stage and need to adjust and diversify their economies to attracting higher value added activities sooner due to limited supply.

Given the above and all the input that needs to be integrated in a forecast, it remains to be seen which countries and for how long they can maintain their competitive position in the global economy and successfully attract more Foreign Direct Investment (FDI).

To be continued………

Dr. Douglas van den Berghe

Managing Director