MICHAEL KEATING. The Official View on the Economic Outlook.

The last twelve months has seen GDP per capita fall in Australia, but the Government and its key advisers still expect the economy to recover to trend rates of growth in the current financial year. Nevertheless, the Reserve Bank is still calling for more fiscal stimulus, while on the other hand the new Secretary of the Treasury has raised the possibility that wage growth (and by implication economic growth) may not return to past trend rates of increase because of structural changes in the economy.

The Government, the Reserve Bank (RBA) and the Treasury are all forecasting that economic growth will recover, with the economy forecast to grow in 2019-20 at an annual rate of 2½ per cent (RBA) and 2¾ per cent (Treasury in the pre-election statement). This is almost twice as fast as the most recent national accounts data which show a GDP growth rate of only 1.4 per cent over the twelve months ending in June.

The authorities argue that the lower interest rates and tax cuts are already kicking in and that housing demand is recovering with consumer demand to follow. Nevertheless, the Governor of the RBA is in the curious position that he is calling for a fiscal stimulus, while he believes that economic growth will recover anyway. On the other hand, the PM, the Treasurer and the Treasury believe that no fiscal stimulus is necessary nor appropriate, short of a crisis which they clearly don’t foresee.

Asked to explain the recent poor performance of the Australian economy, which grew by less than the population, the authorities blame the uncertainty emanating from overseas, such as the trade wars, Brexit etc. Presumably these overseas uncertainties will also provide the excuse if the Australian economy fails to grow in future in line with their forecasts.

Frankly, this is not convincing. The uncertainties generated by Trump’s trade wars and Brexit are very recent, and certainly cannot explain the poor economic performance over the last twelve months to June. Indeed, in that period exports grew by 3.5 per cent in real terms, and net exports accounted for as much as 40 per cent of the total GDP growth, so international demand has been holding the Australian economy up rather than weakening it. Nor do overseas generated uncertainties explain the very poor growth of the economy over the last four years or so, with GDP increasing at half the annual rate of the previous decade, and real per capita household disposable incomes actually falling.

Personally, I am inclined to agree that a recession is unlikely. In my view what is much more likely is a continuation of the economic stagnation that we have been experiencing over the last four years. As the Governor of the RBA, Phillip Lowe, put it two years ago:

The crisis is really in real wage growth

The critical issue then is how much of the recent slow growth in wages, and thus in the economy, has been a response to a cyclical downturn, and how much is structural.

The macroeconomic policy responses so far are only directed at fixing the cyclical downturn in demand. But I think the low wage growth, which has continued for more than a decade in most advanced economies, cannot be explained as only being due to cyclical factors. Instead there must have been structural changes in the labour market, and unless these structural impediments to wage increases are addressed more directly, they will continue to hold back the rate of wage increase, and thereby the rate of increase in demand, and thus economic growth.

Accordingly, to me the most interesting aspect of the first speech by the new Secretary of the Treasury, Steven Kennedy, is that he recognised the possibility that:

“A number of other long-running changes in the labour market may also be affecting the relationship between unemployment and wage growth. An interesting concentration of economic activity in the service industries, the effects of demographic and technological change and globalisation may also have played a role.”

So at last we have someone in a really senior position admitting that there is or at least may be a problem with wages growth, and that we cannot count on wages to return to past rates of increase as the economy recovers. Furthermore, I have argued that we cannot expect the economy to grow at its past trend rates until wage growth improves.

In this context, it is interesting that Treasury’s own recent research using micro data for individual firms shows that:

· the “slowdown in nominal wage growth is relatively broad based”; it is not confined to particular industries and in fact the rate of wage increase in the service industries has been as high as elsewhere, and even higher in health and education, which incidentally have relatively high levels of unionisation.

· the relationship between firm level productivity and wage growth has weakened, suggesting that “some structural factors (my emphasis) may have been weighing on wages”, and that weakened relationship may have accounted for “around 1/3 of the unexplained weakness in nominal wage growth”.

· The rate of job switching by employees from one firm to another has declined, partly associated with decreasing rates of new firm entry, and this decline in job switching is associated with a lower rate of wage increase.

Other research puts most of the emphasis on the impact of new technologies as the main explanation for slow wage growth and the associated increase in inequality. In particular, new technology has most impacted routine jobs, and has thus hollowed-out the middle of the labour force. Thus, in Australia, between 1966 and 2011, the shares of employment in low- and high-paid jobs increased by 2.2 and 17.0 percentage points respectively, while the share of employment in middle-level jobs fell by 19.2 percentage points. Furthermore, this changing structure of employment not only altered the distribution of wages directly, it also probably was a major cause of the decline in union membership and loss of union bargaining power.

In addition, wage growth has become decoupled from productivity growth in many countries, although to a greater extent in some than others. The OECD and the IMF have found that technology has lowered the price of capital goods relatively and that has increased the rate of substitution of capital for labour, thus increasing the share of capital in national income. This substitution is particularly pronounced in industries with a predominance of highly routine tasks and in those companies at the frontier of technology, which are then able to increase their mark-ups, which again puts downward pressure on the wage share. New technologies have also enabled the expansion of value chains linking the different stages of production across countries and this too has contributed to a lower wage share.

In sum, I would contend that for these various reasons, the rate of wage growth is likely to remain low for structural reasons and cannot only be explained as the response to any cyclical downturn in the economy. But that also means that aggregate demand and economic growth are unlikely to recover unless policy is changed to improve the rate of wage growth and/or to lift household incomes.

As I have written before, a full recovery to past rates of economic growth will therefore require the Government to:

· encourage, rather than resist, a faster rate of wage increase, starting with its own employees

· improve the incomes of ordinary households by focussing any future tax relief on them and not cutting the top tax rates as planned by the Government

· increasing assistance to the poorest households by raising the amount of Newstart and rental assistance, and

· most important in the long run, assist workers to adopt and adapt to technological change by significantly increasing spending on all phases of education and training, from pre-schools to better opportunities for mid-career adults to gain new skills.

In short, fiscal policy needs to be restructured to ensure that Australia has equality of opportunity and that people are enabled to fully participate. This necessary policy agenda goes well beyond any short-term fiscal stimulus.

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.

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4 Responses to MICHAEL KEATING. The Official View on the Economic Outlook.

  1. Marcus L'Estrange says:

    Good article but one key reason for low wage growth is the REAL unemployment figures of around 15% unemployed plus 13% underemployed.

    Two years ago Adam Creighton, economics editor of The Australian summed it up well:

    In May 2017, Adam Creighton wrote in The Australian (“Be honest about unemployment”) that, when the under-employed (those who can’t find enough work) and those only marginally attached to the workforce are added to the unemployed, it comes to 23 per cent of working-age Australians (3.37 million). Those 3.37 million were competing for only 170,000 advertised jobs that month.

    I await Michael Keating’s response.

  2. You are in excellent form with your recent posts, Michael. This is exactly what we need to hear from experienced economists. I wish Josh Frydenberg could hear it

  3. Wayne McMillan says:

    Thanks Michael, a fiscal stimulus is long overdue. The Treasury Secretary needs a reality check.

  4. Peter Small says:

    There is nothing public policy can do that will avert what awaits Australia. The best any government can do is try and patch things up so we “muddle along” for as long as possible, five or ten years, who knows .
    The crash when it comes, will be too terrible to imagine, just think off all the “savers” who are at this moment and will in the future take their money out of banks to buy over priced assets to see them crash in value.
    Any wonder governments are building police states as one thing they do know, an angry and desperate populace will await them!

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