It’s time to set an unemployment target

April 16, 2014

By Stephen Koukoulas

One yawning gap in the economic debate in Australia is the lack of a target for the unemployment rate.

Just last week, with the release of a better than expected unemployment result, the commentary was focused on the favourable labour market news sparking speculation that the Reserve Bank of Australia would soon need to increase interest rates as future growth drove the unemployment rate lower.

The business cycles over the past few decades suggest that politicians and policymakers are happy to claim “full employment” whenever the unemployment rate is about 5 per cent. Anything less and there are skills shortages and wage pressures building and it is left to the RBA to hike interest rates to cool demand for workers.

It seems inequitable, unfair and frankly a policy cop-out to be content with, at best, one in 20 of the working age population out of a job. And having the RBA hiking interest rates to implicitly discourage firms from hiring means there are some important shortcomings in Australia’s policy priorities.

This is not to say it is the fault of the RBA, but rather, the structure of the labour market that means Australia has elevated inflation risks whenever the unemployment rate is around that 5 per cent level. At 5 per cent unemployment, skills shortages start to emerge, upside wage pressures start to build and the upper band of the RBA’s 2 to 3 per cent target is put at risk.

The issue, therefore, is to get the level of unemployment at which those wages pressures build lower.

When discussing the labour market, most politicians tend to focus on the number of jobs created, rather than the unemployment rate. This is a weak approach given that population growth will deliver close to 200,000 “new jobs” every year that the economy grows at about its trend pace.

A politician who delivers a wonderful sound grab to “create one million new jobs over five years” is actually doing nothing at all to reduce the unemployment rate. They are merely suggesting they hope to see the economy grow at its long rate trend pace and that jobs created only just matches population growth and no more.

Not for many decades has there been a target for the unemployment rate. This is probably because of the fear of failure among politicians and the often unpopular policies that would be needed to hit a lower unemployment rate.

Prime Minister Tony Abbott is promising to create one million jobs in the first five years of the Coalition Government and two million jobs over 10 years. One cheer to that!

It is a promise that the drover’s dog could deliver given the fact that Australia’s population will be approximately two million larger in five years and four million larger in 10. All Mr Abbott is promising is to find half of the new Australians a job.

Even if Mr Abbott meets his first target of one million jobs in five years, the unemployment rate could well be around the current 6 per cent level, depending on the assumption one may wish to make about the participation rate.

If the participation rate falls a little and one million jobs are created, the unemployment rate will be about 5 to 5.5 per cent. If the participation rate were to rise, the unemployment rate would be at 6 per cent or higher and the number of people unemployed will be approximately 850,000.

It should be noted that because of demographic trends, the labour force participation rate is forecast to trend lower over the next two to three decades.

On many other matters vital to the economy and policy management, there is bipartisan support for a specific target. The most obvious example is the target for the RBA to have inflation held at 2 to 3 per cent over the business cycle.

There are also targets on balancing the budget, or indeed, running a small budget surplus over the economic cycle. Within that, there are targets for growth in real government spending, for the tax-to-GDP ratio to be anchored at a particular level and so on.

Yet no one dares mention a target for the unemployment rate.

The reasons for this obfuscation are reasonably straightforward. The structure of the economy needs to change and even if those changes are delivered, it will take many years – perhaps even decades – to deliver a structurally lower unemployment rate.

Education, skills and training, across the spectrum of the population from kindergarten toddlers to displaced middle-aged factory workers need to be in the sights of a vibrant and far-reaching skills and education platform. When young adults are ready to tackle paid employment, they need to have the skill sets for a modern, high-income economy.

At a different level, when a middle-aged worker is threatened with unemployment as the industry they are in declines or is overtaken by offshore competitors, a retraining and re-skilling agenda needs to be there to ensure there is a strong probability that they can re-enter the workforce rather than being condemned to the remainder of their life on unemployment benefits.

Some of the current unemployed are, unfortunately, close to unemployable because they either never had the skills or education to undertake work or the skills built up early in their working life are now redundant and have not been updated or modified due to poor public policy priorities.

What is also vital is that the current degree of flexibility in the labour market is maintained. Wages need to be high enough to see workers maintain their attachment to the labour market and thereby help keep the participation rate at a higher level. At the same time, wages that are too high may crimp company profits and discourage companies from hiring additional staff as the their businesses grow.

Australia should embrace a target for the unemployment rate and return to the policies that will see a sustainable move to, let’s say, 4 per cent as a first step. It requires some bold and well targeted policy changes that are well known.