Wages and the cost of living

May 14, 2022
A hand pulls $50 bills from a wallet
An increase in the minimum wage in line with inflation to date is unlikely to have much of a negative impact on the economy and jobs. Image: iStock

An increase in the wages of the lowest paid employees, so that they can keep pace with the cost of living, is unlikely to lead to higher unemployment. Instead, it may well help improve overall economic outcomes.

Wages have emerged as the critical difference between Labor and the Coalition in the cost-of-living debate.

Recently Albanese said he “absolutely” supported a 5.1 per cent increase in the minimum wage in order to keep up with the current rate of inflation. It has since emerged, however, that Labor is yet to decide whether to set that target in a formal submission if it takes power following the May 21 election.

True to form, Morrison’s immediate response was to call Albanese a “loose unit” for supporting the minimum wage increase, warning that it would push up costs and lead to job losses. According to Morrison this is a further demonstration of why Albanese ‘cannot be trusted to manage the economy’.

But where does the truth lie?

A starting point for many of us is the experience of stagflation in the 1970s and 1980s, when contrary to the then economic theory we had a combination of high inflation and high unemployment.

The initial catalyst for the high inflation back then was the 1973 oil crisis, but its continuation was underpinned by a wage-price spiral, as wages increased in response to the higher inflation. On the other hand, the high unemployment mainly reflected the fact that the nominal wage increases were faster than the combination of prices and productivity growth, resulting in what was called a ‘real wage overhang’ and a fall in the profit share at that time.

Today, however, the situation is very different, and it is questionable how far the past experience of stagflation is relevant to determining an appropriate increase in the minimum wage today.

First, today the profit share is higher than normal, not lower as it was back then in the 1970s and 1980s.

Second, Labor is proposing to increase only the minimum wage in line with prices. Even including other workers whose pay is tied to the minimum wage, only about 2.6 million workers would be affected, whereas back in the 1970s and 1980s most wages were indexed to the consumer price index (CPI).

Third, because of the fall in migration, and especially the number of overseas students and backpackers, there is presently a shortage of unskilled workers who are paid the minimum wage in industries like hospitality, agriculture, caring and cleaning. Consequently, increasing the minimum wage by 5.1 per cent, or a dollar an h0ur, is likely to be supported by the market, and is only bringing forward what would have happened anyway over time.

Fourth, even many employers are supporting an increase in the minimum wage of around 3 per cent, so we can assume that the minimum wage will rise by at least this amount. The difference between this 3 per cent and Albanese’s 5 per cent, which at most only effects one sixth of total employment, would make a minimal difference to the total rate of wage increase, and surely a resilient economy could handle that.

In sum, an increase in the minimum wage in line with inflation to date is unlikely to have much of a negative impact on the economy and jobs. Furthermore, even an increase in the minimum wage of 5.1 per cent is likely to still see the real wage of low-paid workers falling in the months ahead, as the Reserve Bank (RBA) is forecasting that prices will increase by as much as 6 per cent over the course of this year.
It is therefore legitimate to ask what is the alternative that the Coalition is proposing.

The latest RBA forecast is that nominal wage growth will pick up to around 3 per cent by the end of 2022, and that it will then strengthen further to be 3¾ per cent by mid-2024; the fastest pace since 2012. Presumably this wages forecast is consistent with the RBA’s interpretation of present government policies. Over the last decade, however, the RBA and the Treasury’s forecasts have consistently over-estimated the rate of wage and price growth.

They both believe that all their errors were because, unbeknown to them, the rate of unemployment consistent with full employment (the NAIRU) shifted downwards during the last decade. However, they have not explained the reasons for this shift in the NAIRU. Instead, their argument is that by definition this downward shift in the NAIRU must be the reason for low wage growth.

Of course, wage growth will accelerate as unemployment falls to historically low levels. But that begs the question of how much and how evenly.

The authorities assume that there has been no change in the magnitude of the response of wages to lower unemployment and of prices to an increase in wages. It is just that the relevant curves linking these variables have shifted, but according to official thinking there is no change in their shape.

However, others including me, think there have been structural changes in the labour market that also affect the magnitude of these responses, and therefore the shape of the curves. It is these structural changes that also help explain why real wages have not kept up with productivity growth under this Coalition Government.

Furthermore, wages are the overwhelming source of income for most households and consequently this wage stagnation has constrained consumer demand, which in turn has resulted in low investment leading to lower productivity growth.

Sure, present policies are expected to restore the economy to an equilibrium position, but it will be a less than optimal equilibrium. The likelihood is that the continuation of a Coalition Government, that relies purely on a cyclical decline in unemployment to accelerate the rate of wages growth, will result in a continuation of unsatisfactory wage and economic growth.

Policy needs to address the structural impediments to wages growth as well as relying on a cyclical upturn in wages growth. In this context an increase in the minimum wage, along with the relaxation of public sector wage caps and policies to reduce the gender pay gap may well lead to higher wages and better economic outcomes overall.


See also Ross Gittins in SMH,May 14, 2022, Real wages cut would reduce inflation, but hit the economy

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