Low wages growth has been a feature for a number of years now. Last week the Reserve Bank of Australia released a paper that assessed why. It found there is a perfect storm of economic factors at play that is likely to keep wages growth low for some time.
I think we can officially declare the “wages blowout” fears dead. When the RBA gets to the point of releasing a paper titled Why is wage growth so low? it has pretty well gone past the point of saying with a straight face that the unions, under the Fair Work Act, are running rampant and forcing up wages.
The data, of course, has been supporting this for some time. The most recent wages price index figures saw annual wages growth for the private sector fall to 2.3% and for the public sector to 2.5% – both record lows:
But what is driving this low growth? Clearly the economy is weak, but unemployment, while high at 6.0%, is not at record heights. Indeed, in 2003 when the unemployment rate was 6.0%, wages were rising at 3.3% in the private sector.
The RBA notes that low wages have flowed into extremely low rises in unit labour costs (the average cost of labour per unit of output):
In the 12 months to the March quarter, unit labour costs fell 0.5%. That is lower than during the GFC.
But not only is wages growth low, it is lower than expected.
The RBA notes that compared with estimates by the OECD, Australia’s wages grew by much less than other OECD nations.
The bank also notes that due to the weak economic growth around the world most advanced economic nations are experiencing low wages growth, but it finds that “the decline in wage growth in Australia stands out, with the extent of the forecast surprise for Australia particularly large in the context of OECD countries in recent years.”
The confluence of factors that has led to the record low – surprisingly low – wages growth begins with low employment growth and rising unemployment. But the RBA finds that only partly explains it.
Economists compare wage growth and unemployment on what is known as a Phillips Curve. This is based on the notion that as unemployment falls, the demand for labour rises and thus so too will wages. But the RBA has found that since September 2012, wages have fallen by much more than expected given the rise in unemployment.
Using the average of 1998 to 2012, with the rise in unemployment in the past year, you would expect wages to be rising by about 3.2%, not 2.3%:
The RBA suggests one reason is that firms, unions and even consumers have lowered their inflation expectations. Given the main impact of the GFC occurred six years ago, it has now been a lengthy period of low economic growth – so long that it has become our new normal.
As a rule, union executives generally expect inflation to be higher than business leaders, but the RBA notes that both now expect inflation to grow by less than the 20-year average – as they have thought for over three years:
And when your inflation expectations are low, there is less pressure to have wages grow fast to stay ahead of the growth of prices.
But the RBA notes real wages have “declined markedly, to around zero”. Thus, even though inflation expectations have lowered, wages are still rising by less than inflation – there is more to low wages growth than just lowered inflation expectations.
A large part of the story is the very thing that is causing our decline in economic growth – a drop in commodity prices.
That drop (among other factors) has seen a marked fall in investment in the mining sector and the end of the high-employment, high-income era of the mining boom.
The RBA notes that from 2002 to 2012 real wages did grow steadily, relative to consumer prices, but they actually grew less when compared with the prices that producers received for their output .
This meant that companies, on average, could afford to pay the wage rises because they were themselves making greater profits. As the RBA puts it, “increases in wages benefited employees by more than they cost employers”:
But since 2012, the fall in our export prices has reversed this situation.
The rise and fall in labour costs is closely linked to the rise and fall of prices of output (reflected by an index called the GDP deflator). For a large part of the mining boom, while labour costs were rising sharply, the prices producers were receiving for their output were rising faster.
This meant that in effect the real unit labour costs, or the “labour share of national income”, was actually falling even while workers were receiving strong pay rises, where employers received more of the profits than workers.
Falling commodity prices have meant wages growth has had to be lower because producers could no longer afford it like they could during the mining boom years.
The other cause of low wages growth is our international competitiveness.
During the mining boom, our real exchange rate – which looks at our exchange rate, labour costs and inflation relative to our trading partners – rose faster than our nominal exchange rate:
All other things being equal, a rise in the real exchange rate reduces our international competitiveness.
Since 2012, the RBA notes our real exchange rate has fallen by about 12% due to the combination of a lower nominal exchange rate and “to some extent, a decline in Australia’s unit labour costs relative to our trading partners.”
This has basically been a natural adjustment in the economy, made to improve our international competitiveness.
Finally, the RBA notes that our industrial relations system is more flexible than in the past and that “greater labour market flexibility may be allowing firms to adjust hours rather than heads by more than usual”. Certainly this would explain why during 2012 and 2013 employment growth remained positive while the number of hours worked fell:
Thus, a combination of excess capacity in the labour market from rising unemployment, a slowdown of economic growth, declining inflation expectations, a reversal of the good fortunes of rising export prices, a need to rebalance after the mining boom, and a more flexible IR system have all combined to deliver record low wages growth.
And, unfortunately, the RBA also suggests this weak growth may continue for a while.
It notes that, because this low inflationary period has lasted longer than three years ,many enterprise bargaining agreements (EBAs) have been renegotiated in this period of gloom. Thus low growth is locked in for another three years (the length of average EBAs).
Certainly since mid-2012 new EBAs have contained wage rises below the average rate of all EBAs in existence – and the rate continues to decline:
Even worse, the RBA suggests the fact that “many firms and employees have been reluctant to bargain for wage growth below expected inflation of 2–3%” is due to the historical belief that inflation is generally above 2%, and employers feel that wages rises below that amount are bad for “worker morale and productivity” and can also hurt “the retention of quality staff.”
The RBA suggests that this means recent wage rises have actually been higher than firms would have preferred given the economic condition and thus the “downward pressure on wage growth might remain for a time, even if labour market conditions more generally were to improve”.
So not only has there not been a wages blowout in the past few years, don’t expect one in the next few either.
