from The Conversation — this post authored by Graham White, University of Sydney

The Fair Work Commission is considering whether to increase Australia’s minimum wage. The Australian Council of Trade Unions is arguing for a A$45-a-week rise. Industry, arguing that currently business has limited ability to afford wages increases, wants the increase capped at 1.5% (closer to $10 a week).

While I suspect most people immediately focus on wages as a cost of production for business, it’s worth clarifying precisely what economic roles wages play. There is more than one.

Indeed, wages are certainly a cost. More precisely, their significance for business as a cost is as one component of something economists call “real unit labour cost“.

This is the cost of employing a person in terms of the value of the goods and services a business would produce. Crudely put, this means the proportion of the value of a day’s production that would be needed to pay for a day’s labour. This depends on two things.

Two key influences: productivity and real wages

The first is the real wage – the purchasing power of the worker’s pay packet, which brings into play prices of goods and services. The second is the productivity of the worker – how much the worker produces over a given time.

The real cost of employing a person over time depends on how these two things change. If productivity is growing, then the real wage can grow without an increase in the real cost of labour for business.

But a couple of other economic considerations are relevant when assessing the economic impact of changes in the worker’s wage. The first is that productivity also depends on investment. Changes in technology that allow for greater productivity are often embodied in the new plant and equipment that firms invest in.

Yet what governs investment? This is an age-old question in economics, and perhaps one of the least agreed areas within the profession. But any stab at this question would conceivably point to the expected rate of return on the investment relative to the so-called cost of capital. An economist would typically measure the cost of capital by reference to interest rates, among other things.