Category: Social Trends

Understanding the labor productivity and compensation gap

From The US Bureau of Statistics.

Increases in productivity have long been associated with increases in compensation for employees. For several decades beginning in the 1940s, productivity had risen in tandem with employees’ compensation. However, since the 1970s, productivity and compensation have steadily diverged.1 This trend, which will be referred to as the “productivity–compensation gap,” has received much scrutiny from both academics and policymakers alike.

Although research on the productivity–compensation gap has existed for some time, most work in this field has been conducted at the total nonfarm business sector or similar aggregate level.2 However, the Bureau of Labor Statistics (BLS) publishes a wealth of detailed industry-level labor productivity and compensation data. Industry data can be used to look at this topic from a fresh perspective in order to see what is driving trends in the broader economy. This Beyond the Numbers article studies underlying trends over the 1987–2015 period in 183 industries that are driving some of the widening gap between labor productivity and compensation observed in the nonfarm business sector.3 Most of the industries studied had increases in both labor productivity and compensation over the period studied; however, compensation lagged behind productivity in most cases.

Labor productivity, defined as real output per hour worked, is a measure of how efficiently labor is used in producing goods and services. There are many possible factors affecting labor productivity growth, including changes in technology, capital investment, capacity utilization, use of intermediate inputs, improved managerial skills or organization of production, and improved skills of the workforce. In this article, all references to labor productivity are labeled as productivity for ease of reference. In addition, labor compensation, a measure of the cost to the employer for securing the services of labor, is defined as an employee’s base wage and salary plus benefits. All references to labor compensation are on a per-hour basis and are adjusted for price change but are labeled as compensation for ease of reference.4 Measures of hours worked and compensation cover all workers including production, supervisory, self-employed, and unpaid family workers.

The productivity–compensation gap by sector and industry

To understand the productivity–compensation gap at an industry-level, it is helpful to first consider this relationship in different sectors of the economy. Each sector referenced below in chart 1 represents the combined activity of many individual industries that perform a similar type of activity.5

Productivity outpaced compensation for the 1987–2015 period in all sectors with significant industry coverage except for the mining sector. (See chart 1.) Some sectors including information, manufacturing, and retail trade exhibited major gaps between productivity and compensation, while other sectors such as accommodation and food services and other services showed slight differences. Compensation in chart 1 has been adjusted for inflation with the BLS Consumer Price Index (CPI).

As mentioned earlier, there have not been many studies of the productivity–compensation gap at the industry level. BLS industry productivity data allow for a deeper analysis by providing information on industries that make up each sector in the panels of chart 1. When examined at a detailed industry level, the average annual percent change in productivity outpaced compensation in 83 percent of 183 industries studied. (See chart 2.) The distance of each industry (represented by a dot) to the equal growth rates line indicates the size of the productivity–compensation gap. Industries above the equal growth rates line saw productivity outpace compensation and those below saw compensation outpace productivity. The largest differences between productivity and compensation occur in Information Technology- (IT) related industries such as computer and peripheral equipment manufacturing, and semiconductor and other electronic component manufacturing.

Does the type of price adjustment matter?

As mentioned above, compensation is calculated in real terms by adjusting nominal values to exclude changes in prices over time. The price indexes that are used to adjust dollar amounts for changes in prices are referred to as “deflators.”

The Consumer Price Index (CPI) is typically used to adjust compensation as it measures how the prices of a basket of consumer goods change over time. Thus, using the CPI shows how changes in workers’ purchasing power compare to productivity within their respective industries. In most cases, productivity gains did not equate to a proportional rise in workers’ purchasing power of goods and services. (See chart 2.)

However, the CPI might not be the most appropriate deflator to use when comparing compensation to productivity. Workers are compensated based on the value of goods and services produced, not on what they consume. Using an output price deflator, a measure of changes in prices for producers, instead of the CPI is an alternative that better aligns what is produced to the compensation that workers receive. Each industry has its own unique output deflator that matches the goods and services that are produced in that industry.6

If the output deflator is used to adjust compensation, a different story emerges. Chart 3 shows that the compensation workers are receiving is rising more in line with productivity than when CPI deflators are used to adjust compensation. The largest gaps from chart 2 shrink considerably once this adjustment is made. In fact, the size of the gap decreased in 87 percent of industries that previously showed productivity rising faster than compensation.

Charts 2 and 3 show an interesting contrast in employee compensation—employees are both consumers and producers. Using the CPI as a deflator is appropriate for analyzing the purchasing power of employees. However, from a producer perspective, using the output deflator is more appropriate for comparing the compensation workers receive for the goods and services they produce in their industry.

Components of the productivity–compensation gap

The gap between productivity and compensation can be divided into two components: (1) the difference between compensation adjusted by the CPI and by the output deflator, as detailed in the previous section and (2) the change in the labor share of income.7 The labor share of income measures how much revenue is going to workers as opposed to the other components of production—intermediate purchases and capital.8

Using the power generation and supply industry as an illustrative example, chart 4 shows how the overall gap in labor productivity and compensation within an industry can be divided into these two components. In this case, the decline in labor share and the difference in deflators contributed equally to productivity rising faster than compensation over the period studied. The composition of the gap, however, varies by sector and industry. For example, the software publishing industry posted a 42-percent decline in its labor share while the newspaper, periodical, book, and directory publishers industry experienced a 22-percent increase in its labor share. All 183 industries are affected differently by current economic trends, which would explain why the labor share and difference in deflators vary by industry.

Chart 5 shows the composition of the productivity–compensation gap at the sector level, which varied significantly. The difference in deflators contributed to the gap in seven of the sectors and was particularly large in the information, wholesale trade, and retail trade sectors. The change in labor’s share of income also contributed to the gap in seven of the sectors and was most important in explaining the gap in manufacturing. In the mining sector, an increase in the labor share led to hourly compensation growing faster than productivity. Both of these components are important in explaining the widespread existence of productivity–compensation gaps among U.S. industries.

The composition of the productivity—compensation gap at the detailed industry level shows 79 percent of the 183 detailed industries had an output deflator that increased slower than the CPI. This means that the rate of change in the productivity–-compensation gap grew faster when adjusted by the CPI than by an output deflator. This difference in deflators contributed to the overall gap between productivity and compensation. The median difference in growth rates between the output deflator and CPI was -0.6 percent per year.

The labor share of income declined in 77 percent of industries studied. This means that a growing share of income was going to factors of production other than employee compensation over the period studied. Factors of production include labor, capital (e.g. machinery, computers, and software), and intermediate purchases (purchased materials, services and energy that go into producing a final product). The median growth rate in the labor share of income was -0.6 percent per year. The median effect of the change in labor share was the same as that of the difference in deflators.

High productivity—wide compensation gaps

Industries with the largest productivity gains experienced the largest productivity–compensation gaps. (See chart 6.) This group of high productivity industries experienced huge technological advances during the IT boom. All of these industries saw compensation rise much more slowly than productivity over time. This was mainly due to the difference in deflators. The prices of the electronic components used in production for these industries fell substantially over time. This is in contrast to the CPI, which rose steadily over the same period. The change in labor’s share of income was a much smaller contributor to the gap for these industries but still declined in each one.

The strong correlation between productivity and the productivity–compensation gap was primarily due to the difference in deflators. The relationship between productivity and the change in labor share was much weaker, yet it still existed. The difference in deflators was the stronger effect among high productivity industries while the change in labor’s share of income was the stronger effect among most other industries.

What about the 17 percent of industries that saw compensation rise at least as fast as productivity?  These tended to be industries with low productivity growth or even productivity declines. (See chart 7.) The median change in productivity of these industries since 1987 was 0.4 percent per year. In contrast, the median change in productivity of industries that saw compensation rise slower than productivity was 1.9 percent.

Industries in which compensation grew the fastest relative to productivity include the water, sewage, and other systems industry; the golf courses and country clubs industry; and the newspaper, periodical, book, and directory publishers industry. The first industry had a large difference in deflators, the second industry saw a large increase in the labor share, and the third industry had a combination of these two components affecting the gap. All three of these industries had productivity declines over the period.

Why the decline in labor share?

Although the difference in deflators explains much of the gap, as mentioned earlier, the share of income going to workers has declined in 77 percent of industries since 1987.

This raises the question: if not for labor compensation, what were the revenues used for?9 Industries divide their income amongst three broad groups: intermediate purchases, capital, and labor compensation. Relative changes to both intermediate purchases and capital can affect labor compensation. It is likely that numerous factors are responsible for recent changes in the labor share.

Using the information sector as an example, we can see in chart 8 that some industries had significant declines in labor’s share of income while others had modest declines or even increases from 1987 to 2015. The largest declines in labor share were in newer, information technology-related industries such as software publishing and wireless telecommunications carriers, where labor share declined by 23 and 16 percentage points respectively. These industries also saw a large rise in output and productivity in this period. In contrast, labor share increased by 7 percentage points in the more established newspaper, periodical, book, and directory publishing industry, which declined in output and productivity.

It is important to note that the reason for declining labor share will likely vary significantly by industry. Here are some plausible explanations:

Globalization – Some of the income that might have gone to domestic workers is now going to foreign workers due to increased offshoring (i.e. the outsourcing of production and service activities to workers in other countries). This could have caused intermediate purchases to increase and labor compensation to decrease.10

Increased automation – It is possible that increased automation has been leading to an overall drop in the need for labor input. This would cause capital share to increase, relative to labor share as machines replace some workers.11

Faster capital depreciation – It is possible that the capital used by industries is depreciating at a faster rate in recent years than in the past. These assets include items such as computer hardware and software that are upgraded or replaced more frequently than machinery used in prior decades. This faster depreciation could require a higher capital share to cover upgrade and replacement costs.12

Change over time

The American economy is dynamic and changes over time. These changes appear in the productivity–compensation gap and its components. Chart 9 shows the components of the gap in each sector for the 1987–2000 and 2000–2015 periods. These periods roughly divide the data in half and use an important point in the business cycle as a breakpoint. Several observations can be made based on this chart.

First, the average productivity–compensation gap among the sectors grew faster in the first period than in the second. This was mainly due to changes in the utilities and wholesale trade sectors.

Second, the difference in deflators accounted for most of the gap on average in the first period, but had a smaller effect on average in the second period. This was particularly true in the utilities, manufacturing, wholesale trade, and transportation and warehousing sectors.

Third, there are large changes in labor’s share of income happening in the mining and manufacturing sectors during the two periods. The manufacturing sector’s drop in labor share during the 2000–2015 period was the largest decline observed in any sector and time period. Conversely, mining experienced the largest increase in labor share during the 2000–2015 period.

What about changes over time in detailed industries? Chart 10 shows how the components of the gap changed over time in industries with the highest employment in 2015. These 10 industries, ordered by employment, made up about 39 percent of the total employment of the 183 industries studied. The first three industries in the chart had component effects that flipped direction from one period to the next. Other general merchandise stores industry, which includes warehouse clubs and supercenters, had a very large drop in labor’s share of income in the first period and a much more modest drop in the second. Charts 9 and 10 show that the productivity and compensation dynamics of sectors, and the industries within them, are changing over time and will likely continue to do so as the economy evolves.

Choosing the right tools, focusing on industries

Studying the productivity and compensation trends of industries can help us better understand the productivity–compensation gap observed in the broader economy. It can show which industries have the largest gaps and the extent to which gaps are widespread. It is important to choose an appropriate deflator for compensation when comparing to productivity. Failing to do so can exaggerate the gap, especially for high productivity industries. A full 83 percent of industries studied here had productivity–compensation gaps when the same deflator was used for output and compensation. These gaps came from a declining labor share of income. Sectors with the strongest declines in labor share included manufacturing, information, retail trade, and transportation and warehousing. Although the causes of the decline in labor share are still unclear, focusing on industries may help to isolate and understand the causes unique to each industry.

1 See Susan Fleck, John Glaser, and Shawn Sprague, “The compensation–productivity gap: a visual essay,” Monthly Labor Review, January 2011, https://www.bls.gov/opub/mlr/2011/01/art3full.pdf.

2 For example, see Barry Bosworth and George L. Perry, “Productivity and Real Wages: Is There a Puzzle?” Brookings Papers on Economic Activity, 1:1994, https://www.brookings.edu/bpea-articles/productivity-and-real-wages-is-there-a-puzzle/.

3 The detailed industries in this article include all published industries at the 4-digit NAICS level as well as some industries at the 3-, 5-, and 6 digit level for cases where the 4 digit is not published. There is an exception for NAICS industry 71311, which is used in place of NAICS 7131. This was done because NAICS 71311 is published back to 1987 while NAICS 7131 is only published back to 2007 and the more detailed industry makes up most of the 4-digit industry.

4 The measure of real hourly compensation used in this article differs from the labor compensation measure typically published for the industries examined. Measures of labor compensation typically published are not adjusted for inflation or on a per-hour basis. The measures of real hourly compensation calculated here are available upon request.

5 The sectors in this article are 2-digit NAICS sectors. The detailed industries, defined in the third endnote, are components of these sectors.

6 Industry output deflators are mostly based on Producer Price Indexes (PPIs) unique to each industry. PPIs measure price change from the perspective of the seller. Consumer Price Indexes (CPIs) for individual products are used to deflate output in some industries (e.g. industries in retail trade).

7 The rates of change calculated in this article are compound annual growth rates. One must use logarithmic changes for the components of the gap between productivity and real hourly compensation to equal the total gap in all cases. For most industries, the components sum up to the total gap using either method but may differ by 0.1 percent due to rounding.

8 Intermediate purchases include all of the purchased materials, services, and energy that go into producing a final product. Measures of the labor share included in this analysis are not directly comparable with the labor share measures of the nonfarm business sector, business sector, or nonfinancial corporate sector. The difference has to do with how output is measured at the industry and major sector levels. Measures at the industry level exclude intra-industry transactions but include all other intermediate purchases. Output at the major sector level is constructed using a value-added concept and subtracts out all intermediate purchases. Thus, industry output can be divided between labor, capital, and intermediate purchases, whereas major sector output can only be divided between labor and capital.

9 For another BLS discussion of the labor share of income, see Michael D. Giandrea and Shawn A. Sprague, “Estimating the U.S. Labor Share,” Monthly Labor Review, February 2017, https://www.bls.gov/opub/mlr/2017/article/estimating-the-us-labor-share.htm.

10 See Michael W. L. Elsby, Bart Hobijn, and Aysegul Sahin, “The Decline of the U.S. Labor Share,” Brookings Papers on Economic Activity, Fall 2013, https://www.brookings.edu/wp-content/uploads/2016/07/2013b_elsby_labor_share.pdf. A number of possible explanations for the declining labor share were examined. Analysis showed that offshoring of labor-intensive work is a leading potential explanation.

11 See Maya Eden and Paul Gaggl, “On the Welfare Implications of Automation,” Policy Research Working Paper, No. 7487, World Bank Group, November 2015, http://documents.worldbank.org/curated/en/2015/11/25380579/welfare-implications-automation. Some of the decline in labor’s share of income can be linked to an increase in the income share of information and communication technology (ICT). ICT effects may have had a larger impact on the distribution of income among workers.

12 See Dean Baker, “The Productivity to Paycheck Gap: What the Data Show,” Center for Economic and Policy Research, April 2007, http://cepr.net/publications/reports/the-productivity-to-paycheck-gap-what-the-data-show This is one of many articles that documents the fact that a rising share of GDP goes to replace worn-out capital goods. Income going towards replacing these goods should not be expected to raise living standards.

Aussies expect mortgage rates will keep rising

From The Real Estate Conversation.

Despite most economists predicting the Reserve Bank board will leave rates on hold at today’s board meeting, many Australians expect mortgage rates will rise this year, and are considering switching to fixed rate loans.

Despite most economists predicting the Reserve Bank board will leave rates on hold at today’s board meeting, many Australians expect mortgage rates will rise within six months, and are considering switching to fixed rate loans. The trend towards fixed-rate mortgages was strongest amongst young Australian homeowners.

A new survey by Gateway Credit Union shows that almost one in five respondents with a variable or split-rate home loan are considering making the switch to a fixed-rate loan.

Gateway CEO, Paul Thomas, said the results could reflect increased household financial pressure.

Household debt is at all-time high, said Thomas, adding that “a rise in home loan interest rates may very well tip some households over the edge financially.”

“Borrowers might be seeking the certainty of a fixed rate home loan,” said Thomas.

The research revealed that men were more likely to switch to a fixed-rate home loan than women (22.4 per cent compared with 14.7 per cent).

“Traditionally women tend to be more risk averse than their male counterparts when it comes to investment decisions. However, it seems like men may be more conservative when it comes to home loan repayments, opting to hedge their bets,” suggested Thomas.

Younger Australians were most likely to be considering shifting to fixed-rate loans. Of survey respondents aged between 18 and 29, 32.6 per cent were considering switching, compared with 20 per cent of those aged between 30 and 49, and only 9 per cent of those aged 50 or older.

Thomas said the fact that Australians are considering shifting to fixed-rate loans indicates that homeowners are feeling cautious.

“The fact that mortgage holders are looking to switch their home loans to fixed rate products over the next 3–9 months just goes to show that there is a sentiment of concern. Factors such as out-of-cycle rate hikes, the new bank levy, stagnant wage growth, and high levels of household debt are all converging to create an environment where borrowers need to act with caution,” he said.

Fixed-rate loans “secure certainty and help households avoid financial distress”, said Thomas.

Australians Curb Spending as Household Debt Balloons

From Reuters.

Australia’s economy may have achieved a remarkable winning streak, avoiding a recession for 25 years, but there are now clear signs that the consumers who have driven much of the growth are running out of puff.

With cash interest rates at a record low and house prices near record highs, the nation’s household debt-to-income ratio has climbed to an all-time peak of 189 percent, according to the Reserve Bank of Australia (RBA).

That means there are an increasing number of people who have little cash for discretionary spending – on everything from cars to electrical appliances and new clothes – as their pay packets get consumed by large mortgages and high rental payments in the country’s red-hot property market.

And it’s not as if a sudden plunge in home prices would help – it might well expose and exacerbate the problem, at least in the short run, squeezing many who have bought into the frothy market with high mortgage repayments and little equity in their homes.

“We are seeing a considerable spike in stress even in more affluent households. Large mortgages, big commitments but no income growth,” said Digital Finance Analytics (DFA) Principal Martin North. “Stressed households are less likely to spend at the shops, which acts as a drag anchor on future growth.”

North estimates a record 52,000 households risk default in the next 12 months and that 23.4 percent of Australian families are under mortgage stress, meaning their income does not cover ongoing costs. That compares with about 19 percent a year ago.

“People are up to their ears in mortgages,” said Brad Smith, a car sales consultant at MotorPoint Sydney which has seen a stark slowdown in sales in the past six months. “They are all on a budget. Everyone’s got all their money in houses, that’s how it is.”

Australians are also facing a cash crunch because price inflation in essential items such as food, electricity and insurance is accelerating at a 3.4 percent annual rate at a time when Australian wages are rising at their slowest pace on record, just 1.9 percent in the year to March.

Meanwhile, growth in retail sales, personal loans and luxury car sales are all at multi-year lows, suggesting the household sector – nearly 60 percent of Australia’s A$1.7 trillion ($1.3 trillion) economy – is under severe strain.

A CONSUMPTION PROBLEM

Australia’s love affair with property is worrying the RBA which has repeatedly warned against the danger of excessive real estate borrowing and the impact on spending elsewhere in the economy.

The central bank is reluctant to raise interest rates to cool the property market as it is concerned that would hit domestic demand at a time when real wages growth has turned negative. Besides, borrowing by businesses is growing at the slowest rate in three years.

Still, signs of a spending pullback is prompting economists to rethink Australia’s strong growth projections.

Only last month, the RBA upgraded its gross domestic product (GDP) forecast by 25 basis points to an annual 2.75-3.75 percent by the middle of next year from 2.50-3.50 percent it projected in February.

RBA’s confidence emanates from a levelling off in mining investment after years of steep falls, a rebound in the price of iron ore and coal prices – Australia is a major exporter of both – from 2015 lows, and the home building boom.

However, many believe the central bank’s forecast might prove too optimistic.

Both Morgan Stanley and National Australia Bank believe the economy might have slammed into reverse in the March quarter, after rising 1.1 percent in the December quarter. First-quarter GDP data is due on June 7.

“As the housing market slows, we see consumption growth as a major risk amid record-low wages growth and ongoing headwinds to discretionary cash flows,” Morgan Stanley economist Daniel Blake said.

RETAILING PAIN

Weak consumer spending is proving a huge drag on retailers’ performance, with shares in furniture and appliance chain Harvey Norman and electronics shop JB Hi-Fi both trading near one-year lows.

Retail sales have hardly grown in the past few months. Even online sales have slowed, with all major categories including homeware, games and toys, daily deals and takeaway food shrinking in April, according to the NAB Online Retail Sales Index.

Car sales have flattened this year after solid growth in 2016 while sales of luxury cars and sports utility vehicles are at a four-year low.

For consumers such as Sydney resident Marie-Aimee Guillermin, there’s little ‘play money’ left after stepping into Sydney’s housing market with a A$1.4 million 3-bedroom house last month.

“We thought once we had the house we could take our foot off the brake a little bit but now that we have it I feel even less certain in terms of stability and financial security,” she told Reuters.

“So whether we’ll end up spending a bit more on clothes and restaurants and going out and what have you I don’t see that happening.” ($1 = 1.3377 Australian dollars)

(Reporting by Swati Pandey; Editing by Jonathan Barrett and Martin Howell)

 

Fair Work Commission to cut wages within four weeks

From The New Daily.

More than 600,000 low-wage workers in the services sector will suffer a wage cut on the first day of next month, after a judicial bench refused pleas to cancel or delay cuts to penalty rates.

In a decision handed down on Monday, the Fair Work Commission denied requests from unions for the wage cuts to be postponed for two years or, at the very least, for currently employed Australians to be quarantined from the cuts.

Instead, the Commission chose to stagger the cuts to Sunday loadings, which means workers will have their wages cut every year on July 1 until 2019 or 2020, depending on their industry.

The verdict applies to workers paid Award rates in the hospitality, fast food, retail and pharmacy sectors.

ACTU secretary Sally McManus urged Parliament to legislate against the “devastating” cuts.

“This can be stopped. Our Parliament can stop it. Malcolm Turnbull can stop it,” she told reporters.

“There is a bill before Parliament as we speak and it can be voted on in the next two weeks and bring a stop to these penalty rate cuts.

“These cuts are devastating. It’s $70 a week in total on average for workers. These are the lowest paid workers in our community.”

Employer groups had urged the Commission to not phase in penalty rate cuts at all, arguing this would boost employment sooner.

The Commission dismissed this argument by acknowledging it was “cautious” about any boost to employment flowing from lower rates of pay. Instead, it argued that workers would benefit from “an increase in overall hours worked”.

However, it did decide to impose the public holiday penalty cuts all at once, from July 1, 2017.

Ms McManus disagreed, telling The New Daily that workers would end up “working longer for less pay”.

From July 1, Sunday penalty rates will be cut by 5 percentage points across the four sectors for full- and part-time workers, bringing penalty rates to 145 per cent for fast food; 195 per cent for pharmacy and retail; and 170 per cent for hospitality.

The McKell Institute, commissioned by the ACTU, has calculated, based on 2011 census data, that if the Sunday penalty rate cuts had been implemented in full on July 1, roughly 621,000 workers would have lost $1.4 billion in disposable income a year, with rural and regional areas the worst hit.

Some, such as Warren Entsch, Liberal MP for the worst affected electorate of Leichardt, have dismissed these numbers as exaggerated.

But even if the disposable income and affected worker numbers were overstated by the McKell Institute’s methodology, it would not affect the rankings. Rural and regional workers would remain the worst hit.

penalty rates electorates

The Australian Industry Group said the Commission’s decision was “fair”, but that it would have preferred for the cuts to be implemented straight away, not phased in.

Rob Mitchell, Labor MP for Australia’s second-worst affected electorate, told The New Daily that penalty rates are important because weekend workers “are missing out on what we value in Australia”.

“I know from my experience when I was with the RACV, having to work on Christmas Day and doing weekend work on both day shifts and night shifts, how this had a big impact on family life and the loss of participation in special family occasions,” Mr Mitchell said.

“This cut attacks the young, it attacks the vulnerable. The FWC does its work, and in this case it got it wrong – very badly wrong.”

Mr Mitchell was especially concerned about the impact of the cuts on consumer spending.

“For many in our communities, these cuts will mean that people have less discretionary spend. If they’ve got less discretionary spend, they’re going to be tightening things up, they won’t be going to restaurants or to the shops, so you could actually see a contraction in small town economies.”

How the changes will be phased in:

 

NSW first home buyer demand set to surge post July 1

From CoreLogic.

Abolishing stamp duty for first home buyers is likely to create some headaches for eligible buyers who have recently entered into contracts. Additionally we can expect first home buyer activity to stall before surging higher on July 1 2017. The long term outcome may be self-defeating due to higher demand pushing up prices.

The decision yesterday by the News South Wales Government Premier Gladys Berejiklian to provide first home buyers with a stamp duty exemption for properties with a price tag under $650,000 is likely to boost demand for this under represented segment of the market. Based on recent Australian Bureau of Statistics (ABS) data, first home buyers comprised only 8% of owner occupier mortgage commitments in March 2017, which is only marginally higher than the record low of 7.5% recorded in September last year and well below the long term average of 17%.

According to the latest CoreLogic ‘Perceptions of Housing Affordability’ report, it highlighted that across New South Wales the largest proportion of respondents (48%) identified that stamp duty was the most significant obstacle to housing affordability. Additionally, almost three quarters of respondents (74%) felt that removing or reducing stamp duty would be an effective way to improve housing affordability in New South Wales.

Clearly the state government is responding to one of the most significant pain points for prospective buyers.

The current policy provides a stamp duty exemption to first home buyers purchasing a new home with a price tag under $550,000. The new policy has substantially broader scope, providing an exemption for both new and established housing with a price tag under $650,000 and sliding discounts up to $800,000.

To put these limits into context, over the past twelve months, 45.4% of dwellings sold across New South Wales had a price tag of $650,000 or less and 58% of dwelling sales had a price tag $800,000 or less. The proportion of properties that meet the exemption criteria falls away sharply if the analysis is confined only to the Sydney metropolitan area where 25.8% of dwelling sales over the past twelve months were at a price of $650,000 or less.

With a substantial premium on detached housing, the proportions are also substantially different between the broad product types. The past twelve months saw 20.0% of Sydney houses sell for $650,000 or less while unit sales comprised just over one third of all sales (33.5%) at or below this price.

Additionally, with investor demand likely to be slowing due to higher mortgage rates, tighter credit policies and low yields; there is the potential that a rise in first time buyer demand could fill the ‘hole’ left by fewer investors in the market and offset the recent slowdown in the pace of capital gains.

First home buyers still need to contend with the challenges of raising a deposit, which is another major barrier to market entry. Housing prices in Sydney are the highest amongst the capital cities, with the latest data from CoreLogic putting the median house price at just over $1 million and median unit price at just under $743,000. Those buyers who can’t stump up a 20% deposit have been given another leg up, with stamp duty for lenders mortgage insurance also abolished.

Stamp duty on lenders mortgage insurance is charged at 9% of the premium; so a first home buyer with a 5% deposit on a $650,000 property is likely to save themselves around $2,250 (based on a premium of $25,000).

Removing or reducing the transactional costs for first home buyers is likely to provide both positive and negative consequences across the New South Wales housing market.

From a positive sense, policies aimed at improving housing accessibility for first time home buyers are likely to be positively received. Sydney is Australia’s most unaffordable housing market by any measure, and for many buyers, the cost of entry, including stamp duty and raising a deposit, is the most significant barrier to entry. On a $650,000 dwelling purchase, a non-first home buyer would be paying stamp duty costs of around $25,000; so the exemption is a substantial cost saving for a first home buyer.

On the negative side, it’s widely accepted that policies aimed at stimulating demand tend to push prices higher; there is a possibility that the new policy could ultimately be self-defeating, increasing housing demand which could place further upwards pressure on the price of housing which will exacerbate the affordability challenges even further.

The new policy comes into effect on July 1st, so we can expect first home buyer sales to stall over the remainder of June and likely surge higher from the beginning of the new financial year. For those buyers who are potentially eligible for the new exemptions but have recently entered into contacts, there is likely to be some severe disappointment that these rules aren’t applied retrospectively.

Perfect storm for housing affordability

From Mortgage Professional Australia.

First home buyers’ day of reckoning as Sydney and Melbourne prices drop and stamp duty is slashed

Property prices fell in Sydney and Melbourne over the month of March, by 1.3% and 1.7% respectively, according to CoreLogic’s Home Value Index.

Published yesterday, the Index coincided with an announcement by NSW’s State Government that stamp duty was to be abolished for first home buyers on existing and new properties under $650,000. Discounts on stamp duty will be available on properties up to $800,000.

“I want to ensure that owning a home is not out of reach for people in NSW,” explained NSW premier Gladys Berejiklian “These measures focus on supporting first homebuyers with new and better-targeted grants and concessions, turbocharging housing supply to put downward pressure on prices and delivering more infrastructure to support the faster construction of new homes.”

The state government will commit $3bn of funding for infrastructure and abolish stamp duty charged on lender mortgage insurance for FHBs. Conversely, stamp duty concessions have been removed for investors buying off the plan and the stamp duty charged on foreign investors will double to 8%.

Improving landscape for FHBs across Australia

Prospects are finally improving for first home buyers on the eastern seaboard. Both NSW and Victoria now have stamp duty exemptions for first home buyers and cooling housing markets, with property prices not moving in Sydney and increasing by just 0.7% in Melbourne over the past quarter.

CoreLogic’s data also revealed that prices in Perth and Darwin continue to fall, with sudden reversals in Hobart and Canberra and only moderate growth in other cities.

However Corelogic head of research Tim Lawless warned that price falls may not continue: “The May home value results should be viewed in the context of demonstrated seasonality; values have fallen during May in four of the past five years. Reading through the seasonality indicates that value growth in the market has lost momentum, particularly in Sydney and Melbourne where affordability constraints are more evident and investors have comprised a larger proportion of housing demand.”

Further action by APRA could reduce demand, according to Lawless: “considering we are yet to see the full effect of the recent round of macroprudential measures flow through, there is a high possibility that investor activity, and consequently housing demand, will slow further during 2017.”

Are stamp duty concessions the right way forward?

Former RBA governor Glenn Stevens, who advised the NSW government, has stated he’s not a ‘big fan’ of measures such as grants and concessions as these can simply drive up prices.     He argued that “the government might expect to achieve much more for affordability in the longer run by spending this money in other ways that would lead to lower cost supply of new housing.”

Labor has pledged to scrap negative gearing, although Treasurer Scott Morrison has claimed removing it could actually harm affordability by raising rents.

The UK government has turned against negative gearing for investors, with tax relief being phased out by 2021. This has had a huge effect on prices in London, which grew by 1.5% in the year to March compared with 15% growth the year before.

Sydneysiders blame foreign investors for high housing prices

From The Conversation.

Sydneysiders are concerned that foreign investors, and particularly Chinese real estate investors, are pushing up housing prices, according to survey findings published this month. A majority believed foreign investors should not be allowed to buy residential real estate in Sydney.

The federal budget was the government’s latest attempt at navigating a policy solution that supports its pro-foreign investment position while responding to public concern about housing affordability in Australian cities.

China’s government is also searching for a policy solution to restrict the large amount of capital that’s flowing out of the country. But the Chinese crackdown “doesn’t appear to be working”.

We surveyed almost 900 Sydneysiders to investigate their views on foreign real estate investment. The effectiveness of government regulations on foreign investment and investors was a major concern for respondents.

Views on government regulations

The survey obtained the views of people aged over 18 living in the Greater Sydney region. They were asked about housing affordability, foreign investment, the drivers of Sydney housing prices, and perceptions of Chinese investors specifically.

Support for the government’s regulation of foreign investment in housing was weak. Only 17% of respondents thought it was effective.

Almost 56% of participants believed foreign investors should not be allowed to buy residential real estate in Sydney. Only 18% believed this should be permitted.

More than 63% of participants disagreed that the “government should encourage more foreign investment in greater Sydney’s housing market”. Only 12% of participants agreed with this.

These views stand in stark contrast to the government’s geopolitical support for foreign investment in Australia.

Views on foreign investors

There is little fine-grained data about the impacts of foreign capital and investors on specific neighbourhoods and developments in Australian cities. Therefore, we did not set out to compare public attitudes against the limited empirical evidence on the effects of foreign real estate investment in Sydney.

What’s significant about the survey results is that Sydneysiders have strong views on foreign investment, despite the absence of reliable evidence. Participants’ concerns about foreign investors and investment were consistent with their concerns about the government’s foreign investment rules.

Around 63% of Sydneysiders identified the Chinese as the heavyweights of foreign investment. This is likely to be accurate, given the concentration of Chinese investment in Sydney and Melbourne.

When presented with the statement “I welcome Chinese foreign investors buying properties in my suburb”, more than 48% of participants disagreed.

Other studies, however, have shown the potential for public confusion between domestic Australian-Chinese and international Chinese buyers.

Views on the drivers of housing prices

Respondents were asked to choose up to three drivers of house prices based on their understanding of Sydney’s housing market. By far the most commonly nominated driver of house prices (64% of respondents) was foreign investors buying housing.

Roughly one in three survey participants saw low interest rates (37% of respondents) and domestic home owners (32%) and investors (32%) as the drivers of higher housing prices. Local housing analysts generally agree with this.

But more than three in four participants (78%) agreed with the statement:

Foreign investment is driving up housing prices in greater Sydney.

When framed inversely, as “Foreign investment has no impact or very small impact on greater Sydney’s housing market”, more than two-thirds of participants (68%) disagreed with the statement.

Only 6% of our participants disagreed that foreign investment was increasing real estate prices. Around 11% agreed that foreign investment had no or minimal impact.

Views on housing supply and affordability

We expected people to report that foreign people and capital are driving up housing prices and making it more difficult for Australians to compete in the housing market. But we were surprised by the findings about Sydneysiders’ views on foreign capital and housing supply.

A strong message from the real estate and property development industries is that foreign investment increases housing supply, which in turn puts downward pressure on prices.

Politicians and lobby groups argue this will help improve housing affordability in major Australian cities. But many housing analysts argue that this supply solution does not stack up for purchases made by either foreign or domestic investors.
It seems that Sydneysiders don’t accept the real estate industry message about foreign investors increasing housing supply, and therefore helping to ease housing affordability pressures.

When asked if “Foreign investment can help increase housing supply in greater Sydney”, 48% of participants disagreed with the statement. Another 25% “neither disagreed or agreed”.

An unresolved policy dilemma

The government’s dilemma is how to manage foreign investment alongside an increasing housing affordability problem in major Australian cities.

This month’s federal budget included a crackdown on foreign investors, but the government still supports foreign real estate investment.

Our survey results support other studies that suggest this pro-foreign investment stance must be accompanied by strategies to protect intercultural community relations. This must happen alongside efforts to improve housing affordability.

Authors: Dallas Rogers, Senior Lecturer, Faculty of Architecture, Design and Planning, University of Sydney; Alexandra Wong, Engaged Research Fellow, Institute for Culture and Society, Western Sydney University; Jacqueline Nelson, Chancellor’s Postdoctoral Research Fellow, University of Technology Sydney

Cost of ‘modest’ retirement up 33%: ASFA

Rising costs of living are impacting retired households according to new research.  The figures reveal couples aged around 65 will need to spend $59,971 a year and singles $43,665.

Significant hikes in the cost of power, health care, food and rates over the past 10 years have driven increases in the amounts needed to achieve both modest and comfortable retirements, according to the latest data from the Association of Superannuation Funds of Australia (ASFA).

It is more than a decade since the first release of the modest and comfortable ASFA Retirement Standard (RS) budgets.

Every three months since June 2006, they have tracked the rise and fall of items that comprise average household budgets. Updates reflect inflation and provide detailed budgets of what singles and couples need to support their chosen lifestyle.

Between June 2006 and March 2017, the RS budget at the modest level for a single person increased by 33 per cent, while the single comfortable budget rose by 23 per cent.

The budget for a couple at the modest level increased by 36 per cent and at the comfortable level by around 26 per cent.

ASFA CEO Dr Martin Fahy said the figures compared to an overall 28.6 per cent increase in the Consumer Price Index (CPI).

“The categories of expenditure that really impacted the budgets are not altogether surprising,” he said.

“Over the period, electricity costs increased by 124 per cent, health costs by 60 per cent, property rates and charges by 83 per cent and food costs by 24 per cent.

“Price changes for less essential items tended to be lower and in some cases prices fell.

“The price of clothing fell by a total of three per cent over the period with an eight per cent fall in the cost of communications (including telephone and mobile phone charges).

“The cost of international holidays rose by a relatively modest 16 per cent over the period.”

Over the more than 10 year period, the maximum Age Pension increased in real terms, by 70 per cent for a single person and 54 per cent for a couple, from a starting base far too close to the poverty level.

The Age Pension is adjusted by what is the greater of the increase in average wages or the CPI. During the period, average earnings rose by 43 per cent.

There also were some discretionary increases made to the rate of the Age Pension, particularly to the single rate. However, despite these various increases, the Age Pension alone still does not permit a retiree to achieve even a modest standard of living in retirement at the levels set by the ASFA RS.

The increases in the Age Pension over and above the increase in the CPI and in wages have helped contain the savings required at the time of retirement, in order to support either a modest or comfortable lifestyle.

On the other hand, the tightening of the means test has led to an increase in the amount of retirement savings needed to support a comfortable standard of living in retirement.

Other price increases of interest included: tobacco (not in RS budgets but consumed by many retirees) up by 178 per cent; wine up by only six per cent, but beer up 45 per cent; rents up 51 per cent; postal services up 45 per cent; vet fees (not in RS budgets) up 49 per cent; and, insurance costs up 72 per cent.

Dr Fahy said both budgets assume retirees own their own home outright and are relatively healthy.

“Of increasing concern is the reality of many more retirees at the mercy of the private rental market, so when you consider the increase in renting costs, it highlights the need for increasing numbers of retirees to have much greater super balances to support a reasonable retirement,” he said.

In the latest RS updates for the March quarter, there was a slight increase in the cost of living for retirees, with increases in the prices of petrol, medical and hospital services and electricity.

The ASFA RS March quarter figures indicate couples aged around 65 living a comfortable retirement need to spend $59,971 per year and singles $43,665, both up 0.3 per cent on the previous quarter.

Total budgets for older retirees increased by around 0.3 per cent at the comfortable level and 0.6 per cent at the modest level.

Over the year to the March quarter, there was a 1.8 per cent increase in the budgets, slightly lower than the 2.1 per cent increase in the All Groups CPI.

Dr Fahy said the cost of retirement over the most recent quarter only increased by a relatively small amount but many individuals would still find it difficult to achieve a comfortable standard of living in retirement.

“Over the longer term, the cumulative increase in retirement costs has been considerable,” he said.

The most significant price increases in the March quarter contributing to the increases in annual budgets were for automotive fuel (5.7 per cent), medical and hospital services (1.6 per cent) and electricity (2.5 per cent). Fluctuations in world oil prices continue to influence domestic fuel prices.

The most significant offsetting price falls were for international holiday travel and accommodation (-3.8 per cent) and fruit (-6.7 per cent).

Overall, food prices fell 0.2 per cent in the March quarter. The main contributor to the fall was fruit (-6.7 per cent), due to plentiful supplies of both year-round and summer fruit. Over the last 12 months, food prices rose by 1.8 per cent.

International holiday travel and accommodation prices fell 3.8 per cent due to the winter off-peak seasons in Europe and America.

Clothing and footwear prices fell 1.4 per cent in the quarter, reflecting discounting during the post-Christmas sales.

The price rises for both medical and hospital services and pharmaceutical products reflect the annual cycles for the Medicare Benefits Scheme and Pharmaceutical Benefits Scheme (PBS).

Insurance prices increased 0.8 per cent in the quarter. Over the last 12 months, insurance prices have increased by 6.8 per cent.

Expenditure on education is not included in the retirement budgets but some retirees paying school fees for their grandchildren would be affected by a 4.1 per cent increase in secondary education school fees following the commencement of the new school year.

Experts bust the mortgage deposit ‘myth’

From The New Daily.

When it comes to the housing debate, there’s one number that just won’t go away: 20 per cent.

Many fear that’s how much they’ll have to save for a deposit. It’s easy to understand why – popular measures of affordability, such as those compiled by CoreLogic and CoreData, often assume a 20 per cent lump sum.

Except it’s not.

Back in 2015, the Reserve Bank noted: “the deposit required of a first home buyer is no longer necessarily around 20 per cent of the purchase price, but rather, more often in the 5–10 per cent range.”

Regulators have tightened the screws since then, but there are still mortgages with below 20 per cent deposits to be found, according to Dr Ashton De Silva from RMIT’s Centre for Urban Research.

He said homebuyers taking out bigger loans should consider the benefits of getting into the housing market now, rather than waiting to reach a certain deposit.

“It’s not just a case of working out that you’ve got to pay another $50,000 in interest. What is the economic benefit of securing that place now?” Dr De Silva told The New Daily.

“We expect people are making the decision that: ‘It is better for me to take on that extra cost and secure this dwelling.’”

Two Australians earning the average full-time wage, with average living costs, will likely qualify for a loan just over $1 million with one of Australia’s big banks.

Finder, a financial comparison website, lists a bevy of acronyms that offer low deposit loans, including: NAB, ME, CUA, IMB and HSBC.

Many lenders have created new financial products to help homebuyers enter the market, resulting in Australia having, according to Dr De Silva, “one of the most product diverse markets in the world”.

One option is lenders’ mortgage insurance, which lowers required deposits to a minimum of 5 per cent, meaning purchasers of a $500,000 property can require a lump sum of only $25,000.

Mortgage insurance is usually paid as a one-off charge, with the cost calculated as a percentage of the loan amount and based on the size of your deposit.

Occasionally, it can even be ‘capitalised’ into the value of the loan – which means you borrow more to cover the cost of the insurance. If you do this, you’ll pay slightly higher repayments, rather than a big sum up front.

It’s important to note the insurance only protects the lender against the risk of you defaulting on the mortgage, not you.

You need $200,000 to meet the 20 percent deposit on a $1 million dollar mortgage, an enormous sum for most Australians.

With mortgage insurance, a couple taking out a loan with a 5 per cent deposit would need $50,000, plus the cost of the insurance.

Some lenders won’t charge insurance on loans with a 10 per cent deposit, but this depends on job security and credit history.

Two Australians earning the average full-time wage, with average living costs, will likely qualify for a loan just over $1 million with one of Australia’s big banks.

Dr De Silva warned home buyers should do their homework and weigh up the costs and benefits of different loans.

“One thing that needs to be at the forefront is, ‘Can I afford to ride out any crisis that may arise?’”

Associate Professor Chyi Lin Lee, an expert in property market economics at the University of Western Sydney, pointed to 20 per cent deposits as a main source of difficulty for many homebuyers.

“We need to find an innovative way to help owner-occupiers to get into the market,” he told The New Daily.

Professor Lee said schemes which help homebuyers jump over the deposit hurdle – such as controversial first homebuyer grants – can be successful, despite the upward pressure they put on prices.

A caution: don’t overextend

Professor Lee warned lower deposits shouldn’t be an excuse for buyers to take out bigger loans than they can pay off.

This was backed by Dr Rachel Ong, deputy director at the Bankwest Curtin Economics Centre, who said people taking out loans with low equity can expose themselves to higher repayments.

“It isn’t a good idea to try and lower the minimum deposit because there’s people who might not be able to meet the payments, and the consequences of that are all the negative and quite severe,” Dr Ong said.

“There’s a reason why the minimum deposit is set at what it is.”

First home buyer demand bounces higher

Low rates combined with recent changes to various first home buyer initiatives has helped encourage more potential property buyers into the market, new research has revealed.

Mortgage Choice’s latest Loan Purpose Report found first home buyers accounted for 14% of all loans written by the company in April, up from 12.2% in January.

“In the first quarter of 2017, we saw a rise in the number of first home buyers taking out loans through Mortgage Choice,” Mortgage Choice chief executive officer John Flavell said.

“This growth in first home buyer demand can be attributed to a number of factors, including low interest rates, stagnating property price growth and enhanced first home buyer incentives.

“In the first instance, property prices have started to stagnate across the country, with CoreLogic data showing the median dwelling value in Australia rose just 0.1% over the month of March.

“Furthermore, interest rates remain at historical lows, which has helped keep the cost of borrowing at affordable levels.

“In addition, some states have made changes to their various first home buyer incentives over the first quarter of 2017.

“In Western Australia, the Government announced a temporary $5,000 boost to the First Home Owners Grant. The boost payment is available to eligible first home buyers who enter into a contract between 1 January and 30 June 2017 to purchase or construct a new home, and owner builders who commence laying foundations of their home between those dates.

“As a result of all of these factors, we have seen a slight uptick in the total level of first home buyer demand.”

Looking ahead, Mr Flavell said he wouldn’t be surprised to see first home buyer demand increase further as potential buyers look to take advantage of the low rate environment and various home buyer incentives soon to be on offer.

“In Victoria, some first home buyers will soon be given access to a $20,000 boosted grant. Those purchasing or constructing new homes in regional Victoria will be eligible for the grant.

“In addition, from 1 July 2017, first home buyers purchasing a home with a dutiable value of no more than $600,000 will not have to pay stamp duty – which can be a real financial impost for many first home buyers.

“These two initiatives alone are likely to encourage more first home buyers in Victoria – especially regional Victoria – onto the property ladder.”

But while Mr Flavell said he wouldn’t be surprised to see first home buyer demand climb slightly higher in places like Victoria, he said more still needs to be done by the other states and territories to help this home buyer group.

“While we have seen a slight improvement in first home buyer demand over the first few months of the year, total first home buyer demand remains very low.

“In April 2014, first home buyers made up 17.8% of all loans written through Mortgage Choice. Today, that percentage has slumped to just 14%.

“We believe more needs to be done to help first home buyers get onto the property ladder.

“The Federal Government announced earlier this month that it would allow first home buyers to salary sacrifice part of their income into their superannuation account in order to help them build their property deposit faster.

“While this initiative is great in theory, it is unlikely to have a huge impact. At best, a couple who salary sacrifice a portion of their income into their super might be able to scrape together enough money to pay for the stamp duty charged in markets like Sydney.

“Indeed, there is nothing to suggest that this new scheme will deliver a different result to the spectacularly unsuccessful First Home Saver Account initiative that was launched by the Rudd Government in 2008 and withdrawn from the market in 2014.”