The poor performance of the Australian economy, as further revealed in last week’s release of the National Accounts, raises questions about the longer-term economic outlook and whether the conventional diagnosis of our major economic challenges is correct. Notwithstanding resistance from the Government and some business interests, most economists believe that increased wage growth is essential. However, there is much less agreement about how and when that might occur.
In January the Prime Minister, Scott Morrison, claimed that he had an Economic Plan, and if re-elected he would:
- Create 1.25 million jobs within five years, and
- Return the next Budget to surplus and thus reduce net government debt by about $300 billion to $40 billion in 2028-29.
At that time, I (and others) were sceptical about both promises. Furthermore, the Prime Minister’s so-called “Economic Plan” provided no explanation whatsoever of how these promises would be realised (see my post “The Prime Minister’s Economic Plan”, Pearls and Irritations, 31 January 2019).
Now the updated National Accounts have been released and we learnt that in the first half of this financial year the economy grew at an annual rate of only ¾ of a percentage point. By comparison most economists, including the Treasury, consider that the Australian economy should be capable of growing over the long-run at an average annual rate of around 2½ to 2¾ per cent. Unless the next six months sees an improvement, economic growth for the current fiscal year, 2018-19, will be less than one per cent, compared with the Government’s Budget forecast of three per cent. Furthermore, what growth there has been this year has depended heavily on public spending, not private spending.
This most recent confirmation of a steady and substantial deterioration in Australia’s economic performance clearly came as a shock to both the authorities and to the many members of the commentariat, who usually take their lead from the authorities; and especially from the RBA which provides monthly updates on the economy.
Until recently, the RBA was signalling that interest rate hikes were likely as they expected the economy to strengthen further. Last week the RBA Governor, however, said there is an even chance of either an interest rate cut or an increase. Furthermore, the mood in financial markets has clearly turned negative, with the pundits forecasting two or even three interest rate cuts by next December.
So what has gone wrong?
In fairness, there is increasing recognition by everybody (except the Government) that the underlying cause of the slow growth in the economy is the weak real wage growth. Indeed, over the last two years real wages have only grown at an annual average rate of 1.2 per cent, compared with an average annual rate of 1.6 per cent over the previous three decades, or almost half a per cent more than currently. From a policy point of view, however, that still leaves the question of why wage growth has been so weak?
According to the RBA, the present weakness in wage growth is purely a temporary problem. In their view, the rate of real wages will accelerate back to past norms as unemployment comes down further.
My problem, however, with that view is that:
- Unemployment has come down to around 5 per cent, which is very close to full employment, but so far wage growth remains sluggish. The RBA now considers that the unemployment rate associated with full-employment may have fallen a little below 5 per cent, but in some regions the labour market is very tight already and there is still no sign of wage growth picking up there either.
- Furthermore, if the next move in interest rates is now expected to be downwards that suggests that unemployment is expected to rise rather than fall further in the foreseeable future.
Instead, I think it is much more likely that low wage growth represents a long-run structural problem and is NOT a temporary cyclical problem as claimed by the RBA. My reasons for reaching this conclusion that low wage growth represents a structural problem have been discussed at length in the book, Fair Share, that I co-authored with Stephen Bell, and in numerous articles preciously posted on Pearls and Irritations (see, for example: “The Medium-Term Economic Outlook”, posted 2 October 2018, and “Slow Wage Growth and its Implications for the Government’s Economic and Fiscal Forecasts”, posted 17 December 2018).
In brief, I think:
- We cannot ignore the evidence that low wage growth has persisted in most developed countries for more than a decade, and for as much as four decades in some countries.
- For some time, the impact of this low wage growth on most economies was postponed as aggregate demand, and particularly consumer demand, was maintained by allowing/encouraging increasing household debt. That was particularly true for low income households, who also experienced much lower wage growth than people in the top of the earnings distribution.
- It was this build-up in debt, that eventually led to the Global Financial Crisis. Since then the growth of debt has been more constrained, but many advanced economies have consequently experienced secular economic stagnation.
Unfortunately, even though some economists have finally come to realise that low wage growth is a structural problem, in Australia, at least, they tend to attribute low wage growth to the very low productivity growth experienced in recent years; indeed, less than half past ‘norms’.
The starting point for these (neo-classical) economists is probably a supply-side model where economic growth over the medium-term is exclusively determined by the three supply-side variables – population, employment participation, and productivity. In that model, it then follows that productivity growth usually determines the scope for real wage increases, unless the distribution of income is going to change – a possibility that these economists typically ignore. Nevertheless, such an association between productivity growth and wage growth does not allow us to assume the direction of causation.
In fact there is general agreement that the main source of productivity growth is innovation and technological change. Furthermore, there is no obvious reason to suggest that the rate of new technological discoveries has slowed down. But contrary to neo-classical economists, what ‘post-Keynesian’ economists argue instead is that:
- the actual realisation and actual implementation of new technologies is usually dependent on new investment;
- New investment is largely in response to recent and prospective increases in aggregate demand; and
- Increases in aggregate demand are in turn largely dependent on increasing household disposable incomes, which mainly emanate from real wage growth.
In other words, it is likely in present circumstances that low wage growth is leading to the low rate of productivity growth, and not the other way around as assumed by conventional supply-side thinking in Australia.
Or as Ross Gittins put it in one of his recent articles which discussed these issues: “Our econocrats are like the drunk searching for his keys under the lamppost because that’s where the supply-side light shines brightest”.
Bell. S. & Keating, M., 2018, Fair Share: Competing Claims and Australia’s Economic Future, Melbourne University Press.
Michael Keating is a former Head of the Departments of Prime Minister & Cabinet, Finance, and Employment & Industrial Relations. He is presently a Visiting Fellow at the Australian National University.