Question

Wages, consumption and GDP growth remain sluggish despite an increase in employment.

In the ten years prior to the global financial crisis Australia’s real GDP grew 3.4% on average per year, decelerating to 1.6% in 2009 after the turmoil. Australia showed resilience being one of the few developed nations that still recorded growth in 2009. Since then Australia’s real GDP growth has averaged below 3% but grew just 2.3% for the year ended December 2018 (seasonally adjusted). Inflation continues to be low, yet all key measures of inflation are now currently below the Reserve Bank’s preferred 2 to 3% band. The economic indicators that signal the start of a downturn are emerging in many advanced economies including Australia. Australian households are carrying a high total private sector debt ratio of 121 percent of GDP in June 2018, making us less resilient to future shocks.

Australia is also seeing the lowest growth in wages as a percentage of economic activity since 1959 when official records commenced. This is despite mostly growth year on year in labour productivity over the same period. The clear downward trend in wages share of GDP is visible from 1980 to current, despite short term small fluctuations, with labour compensation as a percentage of GDP falling from 56% in 1980 to 46.5% in 2018. Nominal wage growth has now been around 2% a year since 2015.

Record numbers of Australians are also working a second job. The number exceeded one million persons at the end of 2018 having increased by more than 20% in the past two years. Since 2010 the wage price index shows the real value of wages growth has fallen from 7% to 2.3% whilst secondary jobs have risen from 3.8% to 6.3% of total jobs over the same period. Secondary job roles feature work like caring, office temping, call centre answering, uber driving and other delivery services, and healthcare and social assistance work.

Despite a small rise in the employment statistics in the years since the GFC, underemployment levels have risen from just 2.5% in 1980 to 9% of the labour force in 2018. Underemployment needs to be considered in context with headline employment figures. Younger Australians are more affected by underemployment and disproportionately so. 31% of workers aged 15-19 and 20% of workers aged 20 – 24 are underemployed. Underemployment in other age demographics does not exceed 9%. According to the OECD, Australia has the highest proportion of “temporary” (including casual) jobs in the OECD. With higher underemployment levels the headline employment rate is therefore likely to include a significant number of people who want more work and cannot get it as well as those who may be working two jobs to make ends meet, indicating that the labour force is underutilised.

In an open letter signed by 124 Labour Market, Employment Relations and Labour Law Researchers, Dr Stanford Jim Stanford, economist, claimed Australia was in the grip of a “wages crisis” that “isn’t going to fix itself” citing an “unprecedented slowdown” despite the employment growth. The economists called for various measures as a matter of urgency to tackle the crisis, including raising the minimum wage, strengthening collective wage bargaining, relaxing caps on the public sector and limiting the ability of private firms to outsource. Professor John Quiggin, one signatory to the letter commented;

“for decades, government policy has been designed to weaken unions and push wages down. It’s time to put that process into reverse.”

Australia’s current Treasurer declined to respond to the written concerns of labour market experts. The Prime Minister countered that increasing wages costs on businesses would contribute to loss of jobs. The argument is that tax cuts for business owners will drive investment and create more jobs. The Business Council of Australia supports the idea of business tax cuts and similarly argues against ‘tinkering with wages’ lest it cause ‘higher prices and lost jobs’.

Some businesses claim they are now suffering because of sluggish consumption. The $310 billion retail sector remains largely in recession due to both low wage growth and high debt carried by households. Retail sales growth slowed to 2.2% in the 2018 year. One market adviser warns that big box retail is “slowly dying” with even heavyweights like Bunnings and Dan Murphy’s now facing “significant store closures.” The physical retail sector has already taken a hit from the growth of online shopping. Many jobs in stores like Kmart, Woolworths, Coles and others have been lost to automation such as electronic scan and pay systems. Other local jobs have been lost to the complete automation of factories and outsourcing of call centre operations.

Slow wages growth forces households to reduce their discretionary spending or look for lower priced goods and services. Wages are for the most part spent locally and there will be flow on effects to businesses from stagnant wages growth. Ultimately businesses will see this in lower sales, despite having interests in also keeping cost structures low by pushing for flexible wages and flexible work patterns from their workers. There is a government policy trade off that must be managed well to avoid low wages growth feeding into low consumption growth, thus dragging down economic growth. The signs are there, in the current dilemma that the RBA is attempting to grapple with. Why with a rise in employment are Consumption and GDP growth not meeting predicted growth rates?

Questions:

6.1 What does an economy’s potential output level represent and how is this related to the main types of unemployment?

6.2   What do current unemployment, GDP and inflation statistics suggest about what stage of the business cycle the Australian economy is currently in?

6.3  Using the AD/AS model, and assuming the economy starts at full employment, explain in words the effect of reduced consumption by households.

6.4 Using the AD/AS model, and assuming the economy starts below full employment, explain in words the effect of a decrease in the rate of consumption and the long run self-correction of the economy.

Answer 1

6.1 Potential output level is attained when a country produces maximum amount of goods and services at full capacity and unemployment is at its natural rate. The natural rate of unemployment arises when the economy is at its lowest level of unemployment where inflation is stable. As there is an inverse relationship between unemployment and inflation, when unemployment falls, inflation starts to rise as there is more demand for goods and services. Thus when unemployment rate is very high, its either structural (due to higher technological innovation) or cyclical (fluctuating).

6.2. Employment has increased, but GDP and inflation are low, this signifies that the economy is falling to the recession phase because of low inflation, signifying less demand and employment rates are high only because wages are low, otherwise if the wages would have risen, then unemployment rates would have increased, but as the wages are lower, people are not consuming enough.

6.3. Within the AD/AS model, as the economy starts at full employment the country is already at maximum output, decline in consumption will lead to reduced expenditure and demand for goods and services, this will lead to reduced production as demand would fall and inflation will start to decline while unemployment rates will start to increase.

6.4. The economy starts below full employment, the aggregate supply curve is already at a low point, decrease in the rate of consumption would lead to reduction in the demand further in the short run and low rates of inflation. The economy will self correct in the long run when it reaches the full employment rate when falling interest rates will increase aggregate demand and lower production costs will increase the aggregate supply in the economy.