Why IR reform is not the answer to our problems

May 12, 2020

Making predictions about the future of the economy has never been more difficult.  In the midst of so much uncertainty, however, one development has been absolutely predictable: Calls for major reform to Australia’s industrial relations (IR) system. IR reform is again being proposed as a policy-making priority; as being fundamental to achieving high rates of economic growth over the long-term.

In my view, the policy challenge is to avoid spending time contemplating extensive reforms to the industrial relations (IR) system.

It is still less than five years ago that the Productivity Commission concluded in its Workplace Relations Framework Report (2015, Overview, p.2) that: ‘…Australia’s labour market performance and flexibility is relatively good by global standards, and many of the concerns that pervaded historical arrangements have now abated…Australia’s WR system is not dysfunctional — it needs repair not replacement.’

It follows that there is no basis for thinking that extensive reforms to the IR system can provide major efficiency benefits to the Australian economy. The time spent thinking about IR policy would be much better spent on other policy issues.

Nevertheless, proposals for reform are being made.  A recurring theme is to increase the flexibility of the IR system.  What is meant by flexibility is difficult to identify precisely, as it has become something of a magic pudding?  However, various proponents associate flexibility with wanting to remove minimum employment standards and to reduce union power (and sometimes, staggeringly given the data on days lost due to strike activity since the 1980s, extra prohibitions on strike activity!).

In my view, claims that Australia’s current IR system does not allow sufficient flexibility in employment arrangements hold little water.  There are no better examples than how the system allowed for adjustment to mining boom without a major break-out in wage growth; and accommodated the end of the mining boom without rigidities in wage-setting and negative impacts on employment some had feared.

Flexibility might also be associated with greater discretion given to employers to adjust work conditions as has happened with award revisions due to COVID-19.  In this episode, the imperative has been to preserve employment connections; and to enable rapid adjustment to changed work circumstances and timing.  To allow that to happen, the flexibility allowed by changes to awards has been valuable.  But adjustment is not usually required in response to events that occur with the speed of business closures due to COVID-19.  So while the costs of adjustment imposed on employees to preserve jobs may be justified in the present circumstances, at other times there is just the cost on employees.

An alternative reform path is a shift to industry-level wage-setting.  It is argued that this is supported by the move away from wage-setting via EBAs having caused low wage growth over recent years.  But the sources of the decrease in wage growth since the early 2000s have primarily been cyclical. This is evident, for example, from Phillips curve inflation modelling by the RBA.  I argue that the shift in coverage from EBAs to awards is also occurring due to the business cycle – as employers use their increased bargaining power in a weaker labour market to push workers onto lower wages via awards.  By contrast, there is little evidence of structural change in factors such as the size distribution of business or the characteristics of employment in the period since 2011 that could be claimed to have driven the decline in EBAs.

What follows from the absence of efficiency gains from major IR reform is that the consequences would be primarily distributional.  As I argued in a previous episode when IR reform was being touted as the solution to all our problems: ‘All we should infer from the fact that a particular group argues for a [IR] policy change is that the group expects to be made better-off by the change.’

Suggested IR policy reforms need therefore to be justified on the basis that their distributional impact will be welfare-improving for society; rather than arguing for a phantom efficiency rationale.  In that vein, I do think that the current episode has brought to the fore aspects of the IR system where specific distributional-based reform needs to be considered: the position of casual employees;  further steps to deal with wage theft (likely to be a bigger problem in current circumstances); and providing minimum conditions for gig economy workers.

A final note on major IR reform.  The adjustment costs are big.  Every new IR Act brings extra regulatory burden and causes employers and unions/ workers to spend large amounts of time learning how to operate with the new system.

The way I express this is to say that we need to worry about the IKEA fallacy: We see the furniture in the store and think how good it would look where we live.  But we forget about the costs of putting it together. Similarly with policy. We are great at visualising what they think will be the end product of policy reform, but not so good at taking into account the adjustment costs, a real cost of the reform to society, in getting there.

*This article is extracted from my Labour Market Snapshot for May 2020 on ‘Five labour market policy challenges for now and the recovery’

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