Changes in inequality and in the relationship between wages and productivity help explain the poor economic performance of many advanced economies in this century. Interestingly the Governor of the Reserve Bank indicated that Australia might be facing the same risks of inadequate wage growth, although he felt that ‘Australia’s monetary policy framework is better placed to deal with this world than some others’.
A few days ago, in a significant and widely reported speech the Governor of the Reserve Bank, Philip Lowe, drew attention to the problems that low wage growth might pose for monetary policy. In some ways, this was a first for a senior economic official in Australia. As Dr Lowe himself put it, ‘In years gone by, the more standard challenge was to keep wages in check’.
In most of the other advanced economies, however, a concern about rising inequality and low wage growth is not new. As is well known to anyone who cares to know, inequality has been rising in almost all the advanced OECD economies since the early 1980s. While part of this increased inequality reflects the huge pay rises that the top one percent of the workforce have awarded themselves, in most countries the increase in inequality mainly reflects a hollowing out in the number of middle-level jobs and widening pay gaps across the wage distribution.
For example, in the United States median hourly compensation (adjusted for inflation) grew by only 9 per cent between 1973 and 2014, while productivity grew by more than 72 per cent. Furthermore, this increase in US wages was very uneven, and the majority of workers missed out on any wage increase in real terms. Indeed, Stiglitz found that in 2015 ‘the typical American man makes less than he did 45 years ago (after adjusting for inflation)’. Similarly, in Austria, Belgium, Finland, France, Germany, Ireland, Italy, the Netherlands and Switzerland, gaps of more than 100 per cent accumulated between the rate of increase in productivity and real wages over the decade and a half before the Global Financial Crisis (GFC). Since the GFC real wages are still increasing more slowly than productivity in many advanced economies and have actually fallen in the Eurozone countries most impacted by austerity – Greece, Italy, Portugal and Spain – as they seek to regain competitiveness within the Eurozone.
In our forthcoming book, Fair Share: Competing Claims and Australia’s Economic Future, Stephen Bell and I argue that ‘macroeconomic policy finds it difficult to sustain reasonable rates of non-inflationary economic growth if wages do not rise with productivity’. This is essentially because in that case the incomes of the mass of the population are unlikely to keep pace with potential output, and consequently their consumption and aggregate demand risks falling short of the growth in potential output, resulting in excess capacity and unemployment. The alternative view of neo-classical economists is that the lower wages will increase the profit share sufficiently that investment will respond by enough to more than offset the impact of the decline in consumption on aggregate demand. Recent experience, however, suggests that investment is unlikely to rise sufficiently to maintain economic growth in the face of a shortfall in consumption. Instead, when incomes don’t rise sufficiently, consumption can only be maintained by households going into debt. That is what happened in the United States in the run-up to the GFC, but the increase in debt was unsustainable and led to the GFC.
The response in the United States and many other countries to this shortfall in demand was first to reduce interest rates to zero or even less in real terms. Then when there was no further scope to reduce interest rates they embarked on an unconventional policy of quantitative easing where central banks tried to expand the money supply in the hope that would encourage more lending for investment. Neither monetary response has worked at all well, and the quantitative easing presents some real dangers to the longer-term stability of the financial system. Many central bankers (including Dr Lowe) are even calling on fiscal policy to do more to stimulate demand.
Larry Summers, a former Secretary of the US Treasury and Harvard economist, has argued that the increase in inequality has caused greater saving, as the wealthy save more, and that the neutral interest rate that would balance investment intentions and saving is now so low that we are facing a continuing situation of ‘secular stagnation’. In my view, in the long term there are two possible ways out of this secular stagnation, where low wage growth is causing a shortfall in aggregate demand. The first would be to increase aggregate demand through wage increases, including by better education and training so that more people could get the good jobs that are becoming available through technological change. The second, would be to do nothing, and wait for continuing economic stagnation to erode skills and the capital stock to the point where productivity stagnated and potential output growth fell sufficiently to match the low rate of increase in aggregate demand. In our book, Stephen Bell and I argue that ‘This is already the likely scenario in the United States where employment has been growing strongly, but aggregate demand and productivity have been increasing more slowly than in the past’.
But what does this all mean for Australia? Whether it is by good luck or good management – and I am inclined to believe the latter – the increase in inequality in Australia over the last thirty or more years has been less than in most of the other advanced economies. Equally or even more important for economic and employment growth has been the evolution of the relation between real wage growth and productivity. In Australia’s case, this relationship can be hard to interpret because of the impact of the quite large swings Australia experiences in its terms of trade, and their impact on Australia’s capacity to “afford” wage increases, as measured by the real national disposable income per capita. But if we take the long period of uninterrupted growth since the 1991 recession, we find that the increase in real wages, productivity and real net national disposable income per capita have all been almost the same. More recently between 2002 and 2012, during the mining boom, real wage growth was faster than productivity, but less than the increase in real net national disposable income per capita. Following the peaking of the mining boom in 2012 these relationships were reversed with real net national disposable income actually falling between 2012 and 2016, and real wages then needed to increase by less than productivity, which it did.
My judgement is that equilibrium between productivity wages and real net national disposable income per capita has now been restored. However, that means that if real wages continue to increase by less than productivity then Australia may begin to face the sort of problems of inadequate demand experienced elsewhere.
The Reserve Bank’s judgement seems to be that wage growth will pick-up as the labour market recovers, but there is little evidence of this yet. Instead over the last twelve months there has been no real wage growth while productivity growth continues, albeit more slowly. If that combination of no wage growth and slowing productivity growth continued then we may find ourselves facing the sort of economic stagnation that the United States is experiencing with very low productivity and wage growth.
That would represent a huge cultural shock in Australia, as it has already in the United States, with major implications for future expectations and politics. And even if income inequality did not further decline under this scenario, it would almost certainly destroy equality of opportunity, unless there were vigorous offsetting government intervention.
Michael Keating was Secretary of the Departments of Employment and Industrial Relations, Finance, Prime Minister & Cabinet from 1983 to 1996. The ideas in this article are the main focus of a book by Stephen Bell and Michael Keating, Fair Share: Competing Claims and Australia’s Economic Future, to be published by Melbourne University Press, early next year.