Australia | Mar 29 2017
2016 saw the lowest Australian wages growth in the history of recorded data. Commonwealth Bank modelling suggests a return to normal is still some way off.
– Record low wage growth
– Record underemployment
– No sign of interest rate relief
By Greg Peel
Australia’s unemployment rate has remained fixed in a tight band of 5.6-5.9% for the past twelve months. Australia’s economy has enjoyed uninterrupted growth for a quarter of a century since the Keating recession of the early nineties. Yet in 2016, Australia recorded its lowest annual wage growth since records began.
That was 1969. This means wage growth was lower in 2016 than it was in the GFC and Keating recession, and even the long Oil Shock recession of the seventies.
Yet not so long ago, 5% unemployment was considered “full employment”. Zero unemployment is an unattainable panacea but implicitly a hindrance to the economy anyway, because there’d be no one left to hire and inflation would run amok, so a 5% buffer is considered the ideal mix.
A year ago many an economist was forecasting Australia’s unemployment rate to have reached 6.5% by now, largely as a result of the downturn in mining investment. This would force the RBA into cutting its cash rate to as low as 1%, it was predicted. But that hasn’t happened. The unemployment rate has remained stubbornly under 6%.
The official unemployment rate is, however, misleading. The ABS splits the “employed” into two groups, being full time and part-time. The former works a standard 35 hours a week or more, and the latter works less than 35 hours a week. Among the part-timers are those who chose to work fewer hours and are happy with that arrangement, and those who would like to work full-time or at least more hours than they currently are. The latter group is known as the “underemployed”.
Underemployment
Australia’s underemployment rate is currently at a record high 8.7%. Given the official unemployment rate is a measure of anyone with “a job” it provides no comparison in terms of hours worked. The underemployment rate is where we find the black hole, or what economists call “labour market slack”.
This record “slack” is leading to an historically low rate of wages growth. Employers are under no pressure to increase wages in order to attract/retain the right staff. Employees are not game to ask for a wage rise when they know someone else would be quite happy to take their job.
Wages growth is a fundamental driver of inflation, the other being consumer price growth. But all is intertwined. As the economists at Commonwealth Bank point out, we think of wages growth as driving inflation but the reverse is also true. Again, if inflation is low then employers see no need to increase wages and employees cannot justify asking for a raise.
The relationship is particularly evident in award wage settings. As the CPI is an important consideration in legislated wage levels, a low CPI leads to low wage increases.
It’s all a bit of a roundabout. So how does Australia get off?
As one might expect in an economy so dominated by commodities export, commodity prices are a significant indirect driver of wages growth, CBA notes. Australia’s underemployment rate has been rising since 2011, which is when commodity prices began to decline. A price nadir was reached in August last year, and commodity prices have rebounded strongly ever since. Thus we should, by rights, expect a commensurate rebound in wages.
But there are two issues. One is that the rebound has still left prices well below their 2011 peaks. The other is that the rebound has not brought about a renewed surge in mining investment. It is investment in new projects and expansions that requires labour. The labour requirement of today’s largely automated mining operations is limited. Indeed despite the rebound in commodity prices, investment and investment intentions are still on the decline.
Rocks and Hard Places
CBA uses a complex econometric model to forecast future wage growth. While the model “captures the trend in wages growth well”, according to the economists, the past few years have seen lower growth than the level of spare capacity in the economy (slack) than one would expect. Presently the model suggests wages should be growing at an annual rate of 2%. But 2016 brought only 1.8% growth. The ten year average is 3%.
Based on March quarter data to date, the model forecasts 0.5% wage growth for the quarter, implying a tick up to a 1.9% annual rate in 2017. CBA is forecasting a gradual fall in both the unemployment and underemployment rates from here. Such a fall would take the underemployment rate down from 8.7% to 7% by 2019, lifting wages growth to the average 3%. A return to 3% wage growth in 2017 would require a fall to 5%.
Which is not about to happen. CBA’s forecasts are consistent with those of the RBA, which suggest only a slow return to target inflation. Currently the RBA believes inflation will remain below the target 2-3% comfort zone until 2019, and wage growth will not begin to recover until at least the end of 2017.
The RBA could, of course, hurry things along by again cutting interest rates. But the counterbalance to high underemployment is the historically high level of household debt. And ever-rising house prices. Cutting rates would only serve to further fuel those two bubbles and risk disaster down the track.
CBA does not, therefore, expect further rate cuts, and the economists are not alone in that view. The minutes of the last RBA meeting made it abundantly clear the board is concerned over housing market risks and high levels of debt.
A return to “normal” wages growth is thus some way off, if there is such a thing as “normal” anymore. One is reminded of Donald Trump’s pledge, pre-inauguration, to provide government subsidy to a US air conditioning factory that was otherwise set to move to Mexico, in order to save American jobs. Interviewed after the pledge was made, the CEO declared that the funds provided by the government would be used to automate the factory.
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