MICHAEL KEATING. The Medium-Term Economic Outlook

Oct 2, 2018

The last decade has been characterised by economic stagnation in almost all the advanced economies. But President Trump and Prime Minister Scott Morrison are now promising a rosy future, with the US and Australian economies supposedly returning to past rates of growth. If the two leaders are right that will make an enormous difference, affecting many issues ranging from the mood of their electorate to the future capacity of their governments. But personally I remain sceptical that a return to a sustained higher rate of economic growth is likely, for the reasons given below.

Over the decade ending in 2016 the advanced economies of the OECD grew at an average an annual rate of only 1¼ per cent; less than half the rate of growth of 3 per cent over the previous 13 years from 1993. The US economy, which led the world into the Great Recession, grew at an average annual rate of only 1½ per cent over that period, compared to a previous ‘norm’ of around 3 per cent. By comparison, the Australian economy – the only advanced economy to avoid that recession – grew at an average annual rate of 2½ per cent compared to a previous norm of 3½ per cent.

However, both the US and Australian economies seem to have picked-up over the last twelve months or so, and both Governments are pinning their hopes on better times ahead. The principal evidence for a stronger economy is the increase in employment that both economies have experienced. In the US the unemployment rate is now down to less than 4 per cent, and in Australia the number of jobs increased by 2½ per cent over the twelve months ending in August – significantly faster than normal. Both Governments are claiming that economic growth in their respective countries is poised to return to a sustainable average annual rate of 3 per cent (or more), supported by tax cuts that heavily favour the rich, but from which the benefits will allegedly trickle down to ensure this broad-based recovery in the economic growth rate.

But can Trump and Morrison be believed? Both leaders are never short of self-congratulation. So what I want to explore in this article is how this recent increase in jobs was achieved, what does it signify more generally, and how sustainable is that economic recovery?

The Economic Recovery

In the US, although unemployment is down to very low levels, it is debateable how far the labour market has really recovered. In many ways a better indicator of the strength of the labour market is the rate of employment participation, and as recently as last year, 2017, only 78.6 per cent of the prime-age population aged 25-54 were employed; still 3 percentage points below that proportion in 2000, and lower than in almost all other OECD countries. In other words, ‘full-employment’ in the US has been achieved by many people dropping out of the workforce, and if allowance is made for ‘under-employment’ then significant slack still remains in the US labour market.

Furthermore, this issue of the amount of slack in labour markets is a key consideration when we come to consider the future of wage growth, which in turn is critical to our assessment (below) regarding the sustainability of economic recovery.

But returning to our consideration of the strength of economic recovery, the other factor to consider, besides employment growth, is the rate of productivity growth. Unfortunately, the data for productivity growth are not reassuring. In the years before the Global Financial Crisis (GFC) labour productivity was growing at 2.3 per cent per year on average in the OECD area; understandably, it dropped during the recession, but it still has not recovered and over the past five years the rate of increase in labour productivity in the OECD area has levelled off at 1.2 per cent on average – approximately half the previous rate of growth.

Indeed, in the US the productivity growth rate has averaged less than 1 per cent since the GFC, and it is only in the current year that it is forecast to be close to 1½ per cent; still substantially less than the 2 per cent average rate of increase in US labour productivity growth from 1991 to 2008. By contrast, productivity growth, at least until recently, has held up quite well in Australia, probably reflecting our avoidance of recession. However, in the last four years there have been signs of a slow-down in the rate of productivity increase in Australia too, with the increase in labour productivity averaging only 0.7 since 2014.

A critical question therefore when considering the future for economic growth in the OECD is why has the rate of productivity increase slowed and what will it take for a return to something closer to past rates of increase? We cannot be certain about the answer to this question – or at least not yet – but Stephen Bell and I have argued in our recent book, Fair Share, that the post-Keynesian economists are correct in their assessment. Essentially these economists argue that the decline in productivity growth rate reflects low rates of investment and the atrophying of skills, in response to an inadequate increase in aggregate demand; in turn a consequence of increasing inequality and low rates of wage growth, especially for those low wage earners who have a high propensity to consume.

In our view, a return to a more equitable distribution of income is critical to achieving higher investment and the associated take-up of new innovations. In addition, the jobs being created today are not the same as those which have disappeared because of structural adjustments mainly brought about by technological change and accompanying changes in the patterns of demand, which tend to favour services over manufactures. This will require much more investment in skills training, which should embrace life-long learning.

Sustainable Future Economic Growth

Essentially what triggered the GFC was rising household debt which too often involved dodgy loans to householders that they couldn’t expect to service, especially if interest rates rose. But these loans were themselves a response to the increasing inequality of incomes, and the associated low wage growth experienced by low wage-earners. For example, Nobel Prize winner Joseph Stiglitz cites evidence that in 2015 ‘the typical American man makes less than he did 45 years ago (after adjusting for inflation)’. Thus, the loans were a way of postponing economic stagnation, but eventually they inevitably led to the crisis represented by the GFC. The loans then largely ceased, and with no recovery in the rate of wage increases, aggregate demand has continued to stagnate in most advanced economies over the last decade.

In short, a sustained return to past rates of economic growth will not be possible unless we can ensure a reasonably equitable distribution of income, involving a faster rate of wage increase, especially for the low-paid. Or as the Governor of our Reserve Bank, Philip Lowe, said in 2017 ‘The crisis really is in real wage growth’.

The critical question therefore is whether or not the past rates of wage increases experienced prior to the 1980s, when inequality first started to increase in most OECD countries, will return if and when the labour market begins to tighten? In other words, does the recent wage stagnation really represent a ‘normal’ response to a prolonged business cycle downturn, or has there been a structural change to past relationships?

No-one can be sure of the answer yet, although there are some signs that wage growth has picked up modestly in the US, with the weighted average of nominal wage rates increasing by 3 per cent over the last twelve months – the fastest rate of increase since the GFC. On the other hand, as the saying goes, one swallow doesn’t make a summer, and elsewhere in other countries, rates of wage increase are still much lower than in the past. In addition, what we don’t know is the distribution of recent wage increases around these average rates of increase. Over the last few decades it has been the slow rate of wage increase for the bottom half of the distribution that has been the main problem in sustaining aggregate demand, and less so the average rate of wage increase. As already mentioned, it is the lower-income householders who have the higher propensity to consume, and a more equitable distribution of wage increases will also help sustain aggregate demand by offsetting the lower propensity to consume by high income households.

Certainly the forecasts by the Australian Government and the RBA are based on the assumption that as the labour market tightens the rate of wage increase will return to around past rates, averaging 3 per cent, and as much as 3½ per cent over the next few years when continuing economic recovery is assumed. Personally, I am sceptical that these past relationships between the rate of wage increase and economic growth will be resumed. The evidence for so many countries is that income inequality started increasing as much as 35 years ago, in the early 1980s, mainly due to the changing nature of technological change. Although Australia seems to have responded better than many other countries to the structural changes occasioned by this technological change, and inequality has increased less here, I still think it is wishful thinking to assume that nothing has changed. Instead, we should not ignore the widespread experience of other similar economies over several decades, and that means that we cannot assume that present policies will lead to the promised restoration of a Budget surplus along with tax cuts.

In addition, other fundamental aspects of the Australian economy do not give rise to confidence in future economic prospects. First, the world economic scene is now unusually uncertain as a result of Trump’s protectionist policies, and the OECD has recently revised down its forecasts for the world economy. Second, asset values are unrealistically high in many countries, including Australia, relative to prospective returns. Some downwards adjustment is likely, especially as interest rates start to rise, as they will if economic growth started to strengthen. This downwards adjustment could easily become disruptive. Third, house prices are exceptionally high in Australia. Partly this is a result of supply shortages, but there is a serious risk of a price correction, and a risk of negative equity for some home-buyers, and Australia already has exceptionally high levels of consumer debt. Fourth, business investment is still low relative to GDP for this late into a business cycle – if that is the reason – and this bodes ill for the forecast increase by the Government in the rate of productivity growth.


In sum, for these various reasons I doubt that there will be a return to continued economic growth at past rates. This will only be possible if we accept that relationships in labour markets have changed with the introduction of new technologies. Instead, we need to seriously address the problems of increasing inequality and low wage increases if we want to sustain economic growth.

Michael Keating, AC, was previously the Head of the Departments of Employment & Industrial Relations, Finance, and Prime Minister & Cabinet. He is currently a Visiting Fellow at the ANU, and this article draws heavily on the thinking developed with Stephen Bell in their book, Fair Share: Competing Claims and Australia’s Economic Future, 2018, MUP.  




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