As long as the economy stays sluggish fiddling around the edges will not help

August 13, 2015

12 August 2015

by Stephen Koukoulas

The labour market is being crushed under the weight of persistently weak economic growth to the point where the unemployment rate has risen to a 13-year high and wages growth has slumped to levels not seen for more than 40 years.

The cause of these poor results is clear. The Australian economy has been sluggish for the past seven years. Average annual growth in real GDP has been a substandard 2.5%, which is some 0.5% to 0.75% below the rate of economic expansion needed to keep the unemployment rate steady.

Wages, as measured by the labour price index, rose 2.3% over the year to the June quarter 2015. This means annual wages growth is at its weakest pace in the history of the series, which dates back to 1997. The measures of wages before that show that wages growth is at levels not seen since the late 1960s or early 70s.

Importantly, it means that household income growth is weak. With the inflation rate hovering around the same rate of increase as incomes, real wages are not growing. This means quite simply that householder’s purchasing power is flat, which in turn means that growth in real household spending, a vital element of the economy, will remain severely constrained. With no growth in real household incomes, the only way household consumption can increase is either through a run down in household savings or higher levels of debt.

The fact that household debt is, on any measure, extremely high and savings have been cut over the past two years, will limit these sources of money to fund stronger consumer spending.

The helpful part of the low wages growth is a lower cost for business in hiring more workers. Of course, workers still need to be willing to supply their labour in a weaker wages environment which is problematic as the experience during the ill-fated WorkChoices policy of the Howard government confirmed.

Of most importance for jobs and wages is economic growth. Without a sustained expansion in the economy, employers will not be willing, or indeed able, to employ more staff, regardless of wage rates.

The recent Reserve Bank of Australia (RBA) assessment of the economic outlook was for a further year and a half of economic growth below 3% and only by 2017 did it anticipate growth moving to an unemployment-lowering growth rate above 3%.

In other words, the RBA is saying that the prospects for lower unemployment and any pick-up in real wages appears bleak.

What is needed to get the unemployment rate back below 5% is several years of real GDP growth well above 3.5%. The RBA has done its best to underpin a stronger rate of growth with official interest rates at a record low 2% and the Australian dollar at a fresh six-year low a little above 70 US cents.

The government, on the other hand, has been floundering between some preconceived notion of “repairing” the budget by moving to surplus, but then spending and borrowing at a frenetic pace while it targets key parts of the electorate as the election gets closer.

Even its infrastructure spending plans, which would obviously provide a short-term boost to economic growth and employment, seem stalled. The national accounts data confirm public sector construction work done as a percentage of GDP falling every quarter for the past two years. It is now just a fraction above the record low of the Howard government, which was guilty of underinvesting for the sake of the budget surplus.

Until the economy does pick up steam, the wages and unemployment data should silence those arguing for further wage cuts, including penalty rates as some sort of panacea for fixing the economy.

The current labour market is flexible enough, it is clear, and the best thing policy makers could do to fix the escalating problem is frame a policy agenda for growth. Any further weakness in wages growth through cuts to penalty payments or the minimum wage would actually be counterproductive, with consumers seemingly unwilling to add to debt or run down savings to compensate for the already weak rate of wages growth.