I like to imagine that, if Arthur Conan Doyle were still alive, and had turned his creation, Sherlock Holmes, to solving the economic mysteries of the 21st century, he would have written this conversation:

Economist: “Is there any other point to which you would wish to draw my attention?”

Holmes: “To the curious incident of the wages explosion.”

Economist: “There was no wages explosion.”

Holmes: “That was the curious incident.”

This is, of course, a parody of a famous conversation in Conan Doyle’s _Silver Blaze_, in which Holmes solves the mystery of a horse’s disappearance (and worse) by noting that a guard dog that should have barked when a stranger stole the horse, did not, in fact, bark.

Research released on 10 April aims to solve the mystery of the Australian labour market in contemporary times.

For years, the Reserve Bank overestimated future wages growth and then raised interest rates to quell inflation, refusing to cut them again for fear of a surge in wages growth in a tight labour market that would fuel a new surge of inflation. That is, it feared a new wages explosion – as if the 1970s were to come back from the dead, like Holmes himself.

Yet, despite strength in the labour market, wages have struggled for much of the past decade – though things have turned around recently. So, what’s going on?

Let’s start by looking at just how strong that labour market has been. This chart shows actual, and trend, employment since late 2013 (the start of the Abbott-Turnbull-Morrison era). You can see pre-pandemic growth (the dark blue line) and the pre-pandemic trend (the green dotted line) projected to the present day.

You can see that employment during the pandemic (light blue line) initially dropped sharply. Then, with various stimulus and recovery measures, it slowly returned to trend by the June quarter of 2022, around the time of the last election. Since then, under an ALP Government (dark red line), it has grown at above that trend rate – at a little more than 0.2% per month, compared to a little more than 0.15% a month pre-pandemic.

As a result of sustained job growth, unemployment fell, and has averaged just 3.8% in this term.

You would think that a tight labour market would give workers lots of power, and lead to a long period of high wages growth. But it hasn’t.

And, aside from a tightening labour market, for a long time every other significant trend in the economy and labour market reduced workers’ power. Some, like declining union membership and collective bargaining coverage, the spread of insecure work, and the gig economy, are well known.

Some, like worker non-compete clauses, had been long overlooked – at least until last month’s budget, in which it was announced they would be banned. These clauses in employment contracts (barring workers who quit a job from accepting a job with a competitor for a period) reduce worker power. When a worker does not take up an alternative job offer that would provide them with better pay, because of such a clause, or because they do not know about the job’s existence or because it is too difficult to move jobs or homes, the power of their existing employer is enhanced. That existing employer has the power to pay less to the worker than they would have to if there was perfect information and perfect competition. Firms may have “no poaching” agreements that likewise prevent wages from being bid upwards.

Those are examples of “monopsony” – where the seller of labour (the worker) faces only one or a small number of buyers (potential employers).

If workers, who’d rather be somewhere else, stay put, the effect is similar to that of reducing the number of employers who are competing for the services of an employee. It increases the monopsonistic tendencies in that labour market. Studies suggest lower job-switching rates are associated with lower wages growth.

Firms have discretion as to how they set wages. Any suggestion that they don’t — that instead they have to take some market-clearing wage, as per the perfect competition model of labour markets — ignores the reality of the power that firms have to choose a wage. This power may arise from monopsony. But it may also arise from a weakening of the collective organisation of labour – of the unionisation of workers and ability to bargain collectively or take collective industrial action.

Collective bargaining is an attempt to force employers to offer higher wages. It is a counter to monopsony.

If collective bargaining declines, then the effects of employer monopsony power on wages intensify. One recent American study showed not only that greater employer concentration led to lower wages, but also that the effect increased over time: that is, a given increase in employer concentration led to a greater reduction in wages than in the past.

The authors attributed this to two things. Declining labour mobility made it harder for workers to offset the impact of employer concentration on local labour markets by moving. And weaker unionism made it harder for unions to offset the impact of employer concentration on local labour markets by bargaining. The OECD, too, concluded that the impact of employer concentration has increased over time. A Treasury researcher found the same thing happening in Australia. The impact of employer monospony power on wages can increase in time even if there is no increase in employer concentration itself, due simply to a reduction in other sources of employee power.

From 2014 until 2022, most federal policy changes (if they were able to get through the Senate) also favoured business, and weakened workers’ power. Those, along with the myriad other (and likely more important) forces that reduced employee power, are what enabled wages to be kept low even in a tight labour market.

This altered after the change of government in 2022. Most legislation since then has favoured workers in bargaining with businesses. Wages growth increased. Real wages growth returned. The share of wages in national income, previously in decline, increased.

In _Silver Blaze_, Sherlock Holmes solves the mystery and the horse is found and returned. So it is that the mystery of low wages growth in a tight labour market can be solved: by understanding power. Wages, in part at least, have returned to growth rates of a recent past – though there is still a long way to go.

The research report on which this article is based can be found here.