The Conversation – Page 68 – Digital Finance Analytics (DFA) Blog

Amazon shows Google tax can work, despite arguments against it

From the Conversation. In late May, Amazon announced it had started to pay tax on its sales in the UK rather than in Luxembourg. This came about after Amazon restructured its tax structure in Europe in response, at least in part, to the UK’s diverted profits tax (commonly known as the Google Tax) that came into effect in April.

Book publishing giant Amazon has responded to the UK’s Google tax by restructuring its European tax affairs. Image sourced from www.shutterstock.com

This development is important not only for the UK, but also for Australia. Treasurer Joe Hockey has announced that the government will introduce a similar Google Tax in 2016. It is especially important when some submissions to the draft legislation of our Google Tax have argued that it is not a good idea for Australia to introduce the tax.

The Law Council of Australia has argued in its submission that the proposed regime is:

…inconsistent with the design principle for a tax … system that tax rules should be applied to commerce in accordance with the structure and mechanisms by which commerce operates.

It basically argues that the tax law should respect the corporate structures of multinational enterprises even if they are tax driven. In other words, its submission does not support the idea that the Australian Taxation Office (ATO) should have the power to deem Google or Amazon to have a taxable presence in Australia.

That argument is questionable. The hard practical matter of fact is that multinationals at present are able to design their tax structures in such a way that substantial activities are being done in Australia but profits are booked in low or even no tax jurisdictions. And these structures are perfectly legal under the current tax law.

It is important to remember that the current international tax regime has been developed largely at a time when multinationals were much less integrated than today. The rules were designed primarily for a bilateral scenario in which, for example, a US company sells goods directly to Australia. None of these countries were tax havens.

However, the stories of Apple, Google and Microsoft have proved that the scenario is very different today. Multinational companies have been successfully converted this kind of bilateral transaction into multilateral transactions by inserting low-tax countries between Australia and the US.

If we believe that this outcome is not acceptable, the tax law has to be improved to address this issue. The general principle of “applying tax rules to commercial operations” should be premised on the assumption that the transactions are genuine with commercial substance. However, if a transaction is artificially created primarily for the purpose of generating low-taxed income, there is a good basis to argue that the tax law should empower the ATO to look through the legal form of the transaction and impose tax according to the economic substance. Therefore, a deeming provision is not only desirable but also necessary in these cases.

Some submissions have also argued that the proposed Google Tax should not apply to existing tax structures. For example, the Law Council suggested that the proposed rule “ought not to apply to existing, well understood and generally accepted business arrangements, particularly where many of the arrangements are longstanding … Existing arrangements ought to be quarantined from any application of the measure”.

If the government follows this suggestion, the proposed law will not apply to the existing tax avoidance structures of Google, Microsoft and Amazon. As most multinationals would presumably have been well served by their tax advisers and have their tax structures in place long before the government’s proposal, one would wonder whether this grandfather treatment will leave any major multinational subject to the proposed law at all.

To be fair, many submissions to the government have rightly pointed out that the draft legislation needs substantial improvements before the proposal can be effective as well as satisfying as far as possible the tax policy objectives of simplicity and fairness.

For example, the Law Council’s submission has highlighted the need to have clear definitions of some new concepts in the proposed law. The meaning of “no or low corporate tax jurisdiction” – which is one of the conditions before the proposed law will apply – should be stipulated explicitly in the legislation. This will not only provide certainty to both the ATO and multinational companies, but also serve more effectively as a clear signal of the level of tax that is not acceptable to the government.

The recent restructure of Amazon suggests that the government’s proposal to introduce a Google Tax in Australia is in the right direction. The experience of UK’s Google Tax shows that such a tax can change the behaviour of these large corporations.

Of course, more work has to be done to improve the drafting of the legislation before the tax can be an effective weapon to deal with aggressive tax avoidance structures used by multinationals.

Author: Antony Ting – Associate Professor at University of Sydney

Five Reasons Housing Is More Affordable Overseas

From The Conversation. Housing affordability continues to be an issue of importance to voters, with a recent Fairfax-Ipsos poll showing 69% of Australian capital city residents disagree that housing is affordable for prospective first home buyers.

Different countries have adopted varying approaches to improve access to affordable housing – with governments playing a central role in ensuring people are adequately sheltered, as well as being encouraged to buy housing where possible. In many countries there is an underlying desire by households to own their own home, although renting is the norm in others.

More than 84% of households in Berlin rent their home. exilism/Flickr, CC BY-NC-ND

In each case there are specific and sometimes unique-to-that-country approaches that have helped address the issue of affordability. Here’s five.

Government intervenes in the rental market

In some countries there is a general culture of renting for accessing accommodation, rather than assuming all households should achieve home ownership. At times, renting is cheaper than buying. In Germany most households (54.1%) are renters due to the long-term intervention in the marketplace by the government, as well as the accepted culture that renting is suitable over the long-term. In Berlin a total of 84.4% of all households rent. Providing this amount of rental accommodation is a major challenge without substantial government intervention and/or provision of housing.

For example, in Germany a housing allowance was paid to approximately 783,000 households in 2012, equating to 1.9% of all private households. However most of this funding was allocated to single person households (57%) unable to compete in the open housing market with multiple income households.

Other countries have acknowledged the gap between (a) the maximum amount of rent a tenant can pay and (b) the minimum level of rent a landlord will charge. For example in the US, this gap is bridged by the widespread use of a voucher system which subsidies the payment of rent to private landlords. This system is funded by the US government and ensures tenants can access a minimum quality of affordable housing.

Government provides affordable housing

In Singapore there is a high level of government intervention in the market with the HDB (Housing and Development Board) providing approximately 80% of all housing in the country. Approximately 90% of households in Singapore own their own home and there are also grants for first time buyers and second time buyers in Singapore.

In Hong Kong about 29.7% of residents live in PRH (public rental housing) provided by the Hong Kong government. In Scotland a large proportion of the supply of affordable housing is undertaken by housing associations and local authorities. This collectively equates to about quarter of total housing accommodation in the market. However the recent trend for many countries, including Australia, has been the provision of less direct housing by governments.

Cities embrace higher density housing

There are numerous examples of global cities making better use of limited inner-city land supply by encouraging higher density living in high rise units or condominiums, especially in Asian cities including Hong Kong, Macau and Singapore. The provision of affordable housing for purchase or renting is therefore more likely to be achieved in these circumstances due to minimal land use and higher densities. However high-rise living is not commonly accepted in many European cities or in locations with a resistance due to cultural preferences for detached housing.

Public transport allows residents to commute to less expensive housing

The main driver of where a household lives is the need to be close to their workplace. As more affordable housing is usually located away from the central business district, households can buy cheaper homes but the trade-off is additional commuting time to work. When this extended commuting time (e.g. up to 2 hours each way) is combined with improved transport infrastructure such as in Japan, it is possible to access affordable housing in outlying satellite towns and cities where land is more affordable. Therefore governments which improve road and public transport infrastructure also increase access to affordable housing.

Multiple person households are encouraged

Lower demand can be achieved by limiting population levels and underlying demand for housing. But while this may not be an option for many governments, another option is to encourage multiple person households which otherwise would remain as single person households. According to the ABS (2012) in 1911 the average persons per household was 4.5, decreasing to 2.7 persons per household by 1991.

List of countries by number of households

Wikipedia compiled from various sources.

Author: Richard Reed, Chair in Property & Real Estate at Deakin University

The facts on Australian coal production

From The Conversation. Talk of the demise of Australian coal production is largely political, not economic.

The problem for the countries that presently mine and burn coal is that there are currently few low cost alternatives. Most countries in the world today are focused on trying to ensure their citizens have access to electrical power. This is difficult without low cost base load electricity production and at present, coal provides an affordable solution.

As at the end of 2012 there were 75 countries producing coal. These countries ranged from Nepal with production of 17,640 short tons in 2012, through to China with production of 4.017 billion tonnes in the same year.

It’s worth noting that Australia was ranked 5th (after China, the United States, India and Indonesia) with coal production of 463 million tonnes in 2012. While these rankings move around a little over time there is no doubt Australia is still a major player in the market for coal.

Regional coal production

U.S. Energy Information Administration (EIA) U.S. Energy Information Administration (EIA)

If you focus on regional coal production since 1980 (see chart above), it is clear production in most regions is levelling out or falling except for Asia and Oceania. When you break this group down there are four major producers involved: China, India, Indonesia and Australia, with a large number of other countries producing considerably less. This is evident in the chart below. Coal production has increased in each of these countries since 1980 though the rate of increase since 2000 is greatest for China.

Coal production by China, India, Indonesia and Australia

U.S. Energy Information Administration (EIA)

While Australia’s coal production is important, it is not the largest coal producer. There are a number other countries in the world that produce very large amounts of coal. If Australia were to cease production of its coal there would be an initial increase in world prices. Nevertheless, it is expected that other producers would fill the gap, particularly given the more recent falls in demand for coal.

If the demise of coal was close, you would expect to see it in the share prices of coal producers, as investor expectations shifted on the future of the firms and their ability to produce cash in the future.

The figure below provides standardised total returns for two portfolios of coal companies listed on the Australian Securities Exchange. The figure also includes the S&P/ASX 200 share market index standardised portfolio value for the same period and the AUD price of Australian thermal coal. There were four miners (including BHP Billiton) included in the portfolio early in the 2000s though this quickly expanded to 10 by 2005 through to 21 from 2011.

The portfolio values and the share market index are standardised to a value of A$1.00 at the end of December 1999 and the total returns are compounded over the period to provide an indication of how the value of the coal mining firm portfolios and the share market have changed over the period.

There is a fair spread of different sized coal producers in the portfolio including BHP. Portfolios are graphed both with and without BHP Billiton, though inclusion of BHP Billiton has little impact. Private non-listed companies are not included in the portfolios.

Coal equally weighted portfolios of ASX listed coal producers

Datastream for share prices and share price index and Index Mundi for the Coal price. Index Mundi

Coal company values have been volatile, relative to the Australian share market (S&P/ASX200 index) over the last 15 years, particularly since 2006. Yet, there is also evidence of some stability over the last couple of years, particularly since 2012.

Coal mining company values have fallen since 2011 though they appear to have stabilised by 2013. The overlaid AUD coal price per tonne tells a different story with its highest price recorded late in 2008 followed by price falls for the remainder of the period. These results are not consistent with the collapse of the coal industry. Indeed, the recent stabilisation of coal mining company prices, after the collapse of 2011 suggest a quite different story.

The anti-coal movement is gaining momentum in Australia. AAP

Given these results it seems odd that superannuation funds and large investors might be considering divesting their investments in coal. There is no question that coal mining company share prices have fallen dramatically from the highs of 2011 but it is not altogether clear that that these companies will disappear in the near term given current share prices. And it would be a brave investor that chose to divest its investment in BHP Billiton or Rio Rinto Limited because part of their business involved the extraction of coal.

It would appear that carbon capture and storage has failed to provide the solution to the CO2 emissions generated from burning coal, yet alternative sources of energy are relatively expensive at present. Governments can change the relative cost of coal through carbon markets, carbon taxes or direct legislation. Yet the global reality for coal appears to be reflected in coal mining share prices. The economics suggest it is here to stay for some time yet.

Author – Richard Heaney, Professor at University of Western Australia

Australians are saving more, but are more comfortable with debt

From The Conversation. Australians know that adequate savings can help provide for a rainy day, help a family put down a deposit on a home, or ensure a comfortable retirement.

Debt also offers a way for households to make purchases that would otherwise be impossible and to achieve a higher current standard of living. Debt invested into an asset that will also grow in real value and is able to be serviced without placing too much ﬁnancial pressure on a household, is generally considered to be good debt.

The key is balance. Since the 2008 financial crisis, Australians have actually decreased their propensity to take on debt and have increased their savings. But debt rates still remain uncomfortably high and there is evidence that this savings discipline is beginning to fade. Have we grown too comfortable with debt?

Household debt is three times what it was 20 years ago. Image sourced from www.shutterstock.com

Saving more, but more indebted

Bankwest Curtin Economics Centre’s second ‘Focus on the States’ report, Beyond our Means? Household Savings a Debt in Australia finds Australians have more debt and are more comfortable with it.

While household savings portfolios have seen an increase of 54% in real terms since 2005, household debt has risen by 51% in the same period. Many households are able to access and service this debt, with higher debts associated with higher incomes. On average, Australia’s estimated 9.1 million households have savings in the form of ﬁnancial assets of $340,900 and debts of $148,700.

However, there is a gulf between those at the top of the distribution and those at the bottom. The inequality in the distributions of household savings and debt are considerably worse than the much talked about inequality in incomes.

The average household disposable income of the top 20% of savers is less than four times those in the lowest savings quintile. However, their savings at an average of almost $1.3 million is 200 times the bottom 20%. This top quintile may receive one-third of all income, but they own three quarters of the total value of savings in the form of ﬁnancial assets.

Average household savings by savings quintile, Australia 2015 (mean $‘000)

The trifecta of debts, low (or no) savings and low incomes presents many low economic resource families with an unenviable challenge to maintain an acceptable quality of life for themselves and their families on a day-to-day basis.

Since the global financial crisis, the household savings rate have risen, with households exhibiting discipline in their expenditure at a time when the economic outlook was uncertain. In an economic downturn income can decline quickly while reining in spending can be more diﬃcult, for both households and governments. Debts can quickly get out of hand and become unmanageable in this situation.

Becoming used to debt

While Australian households have decreased their propensity to take on debt and have increased their savings in the post-GFC period, household debt still remains three times higher now than what it was 20 years ago. Australians are now more comfortable with debt and currently hold debt equal to 1.5 years of income, whereas in the past they had only debt equivalent to six months of annual income.

The share of debt associated with investment property loans has tripled from one-tenth to three-tenths between 1990 and 2015.

Unlike previous generations accustomed to more rigid ﬁnancial products, current households can access a greater number of ﬁnancial products, which have arguably become more complex and more ﬂexible.

This flexibility delivers beneﬁts, but with complexity comes risk and it is important to promote good ﬁnancial decisions and encourage a longer term outlook. Mortgage equity withdrawal has become a popular tool to derive a higher current standard of living by using the family home as collateral.

More households now use these schemes to smooth consumption or relieve short-term ﬁnancial pressures. But this may have contributed to the average mortgage debt as a proportion of property values almost tripling over the last 25 years, rising from 10% to 28% since 1990.

Ratio of housing debt to housing assets, June 1990 to December 2014

Another issue is the use of superannuation savings to pay down mortgage balances, leading retirees to rely more on the pension.

So are we living beyond our means? With household debt to income ratios three times higher now than a quarter of a century ago, household debt up by over 50% in real terms over the last decade and the debt of those approaching retirement (55-64 year olds) up 64% in real terms, it would seem on the face of it to be true.

However, the reality is more nuanced. Household savings are growing faster than income and 8.5 cents in every dollar is being saved, and there is now $2 trillion tucked away in superannuation, while riskier investments are making way for more a more conservative approach. This is far better than we were 10 years ago, but with a note of caution that savings are again on the decline.

Authors: – Alan Duncan, Director, Bankwest Curtin Economics Centre and Bankwest Research Chair in Economic Policy at Curtin University and Rebecca Cassells, Adjunct Associate Professor, Bankwest Curtin Economics Centre at Curtin University

A home of your own: dream or delusion?

From The Conversation. The appeal of owning a home seems deeply embedded in the psyche of Australians. Yet psychologically, it is not clear the home ownership dream is entirely rational. Achieving the dream may not be all we might have hoped, and chasing it may even do damage.

We’d all like a castle of our own, one day. Image sourced from Shutterstock.com

The psychological reason Australians want to own their own home is perhaps best expressed by Darryl Kerrigan in the uniquely Australian film, The Castle. It continues to be celebrated globally for showing that the house is just a shell that holds heart. To own your own home has a strong sentimental value, as Darryl says: “You can’t buy what I’ve got.”

According to data on social trends from the ABS, the dream is not merely a distant aspiration, but one achieved by a majority of the Australian population. More than two out of every three Australians are living in their own home, a figure that has been maintained across a number of decades (see below).

Australian Bureau of Statistics ABS Australian Social Trends 6530.0 & 4102.0

However, the data also show that the proportion who own with a mortgage is increasing (and the proportion without is decreasing). So the dream continues to be made a reality even if home buyers need to borrow more money to achieve it.

Dare to dream

What harm can there be in having dreams? Well, there is a sizeable minority who perhaps do not achieve their dreams. And dreams that keep us awake at night are not good.

Joe Hockey’s recent remarks suggesting would-be home owners “get a good job” were labelled as insensitive and drew a great deal of ire.

The public reaction reinforced the fact that we have a strong attachment to the dream of owning our own home. But why this attachment? While we need a place to live, and housing is for many a form of retirement saving, the desire to own our own home goes beyond these needs.

It’s a global desire, judging by the substantial home-ownership rates around the world – from 98.7% in Romania to 44.0% in Switzerland.

Across cultures and across age groups, one of the motivations for possession of anything is to have the ability to control that possession. In the case of a house, this might be to nail up pictures, paint walls and remodel the place.

The real cost of ownership

But this desire to own, the wish to possess, comes at a cost. First, there is considerable research suggesting we tend to overweight the value of owning stuff as opposed to simply having access to use. Called the endowment effect, it describes the way in which we tend to place a higher value on an item that is owned than on an identical item which is not owned.

Surprisingly, and perhaps of greater concern, is that ownership of a home does not appear to necessarily make people happier. One researcher found that women who owned their own home were no happier than those who rented.

More generally, the rent vs buy debate seems to focus the issue on elements that turn out to be less relevant to our longer-term happiness. We make choices based on big differences (such as rent or buy) when the two dwellings are in most other respects, very much the same.

In this case, we are falling for the focusing illusion whereby we exaggerate the joys of home ownership. Psychologist Daniel Kahneman explains this concept with regard to the myth of California happiness.

And once we get to be a home owner, the pleasure we so anticipated can quickly disappear through the phenomenon of hedonic adaptation. We imagine that owning our own home will make us very happy, and while this may be true in the short run, our happiness levels return quickly to whatever they were before the event.

Hedonic adaptation diminishes both acute negative and positive experiences. And this may explain why home ownership rates and desires bounced back quickly in the US despite the punishing lessons delivered during the global financial crisis of 2008 when many held mortgages of greater value than their home.

We might be inclined to argue that home ownership is a good investment, that “rent money is money down the toilet”, but we may be engaging in a confirmation bias. That is, interest and council rates are a similar “waste”, but we discount this argument because we already believe home ownership is good.

In any case, the walls and roof within which we live do not make the home. While we may justify our dreams with reasons, the truth of the home ownership dream is probably closer to the heart than the head.

Author – Stephen S Holden Associate professor at Bond University

Rogue Bankers Join the Welfare Cheats on Osborne Hit List

From The Conversation.

Cracking down on bad behaviour. EPA/Andy Rain

“The age of irresponsibility is over” declared the governor of the Bank of England at the annual Mansion House dinner to the great and the good of the financial world. Along with the chancellor of the exchequer, George Osborne, Mark Carney unveiled a host of new sanctions and procedures designed to clean up financial markets.

Delivering the Fair and Effective Markets Review, an annual assessment of the way financial markets operate, they mentioned 11 recommendations ranging from new regulations against manipulating markets to tightening up hiring and training policy in the financial services industry. But the most eye-catching feature of the review was the demand for enhanced criminal prosecutions of “individuals who fraudulently manipulate markets”.

In Osborne’s words, people “who commit financial crime should be treated like the criminals they are”. The review therefore recommended that criminal sanctions for market abuse should be extended to traders in foreign exchange markets and that the maximum sentences for wrongdoing should be lengthened from seven to ten years.

Osborne and Carney were also critical of the Bank of England for failing to identify risks and abuses in the banking system in the run up to the financial crisis. But there are actually far more parallels between Carney and his predecessor, Mervyn King, than you might assume on the evidence of the Mansion House speech.

King, who experienced the banking crises (bail-outs and scandals) in the last few years of his governorship, was also critical of the failures of the largest banks. Carney has followed in his stead, voicing his criticisms of the industry, and has enjoyed new powers as a result of the Financial Services Act, passed in 2012. Strong criticisms have therefore been accompanied by new regulatory bodies such as the Financial Policy Committee and Prudential Regulatory Authority (replacing the old Financial Services Authority).

Culture change

But the real message behind the Mansion House speeches is that the state’s approach to policing the banking system is indeed toughening – precisely because change has been so slow in forthcoming. Amid the creation of new, formal regulatory bodies (FPC, PRA, FCA), a host of other relatively informal, or advisory bodies have emerged too.

These include the Parliamentary Committee on Banking Standards and the Banking Standards Board. Another one was recommended in this latest review – the Market Standards Board. What all these bodies have in common is that they are trying to remedy irresponsible behaviour on the part of individuals working in financial services, and to improve the “culture” of banking.

Improving banking culture has two faces. It is partly a PR exercise aimed at improving consumer confidence in the banks. But it is also about addressing a more substantive threat posed by bad behaviour.

That change in culture has been slow. The recent forex scandal, for example, revealed that corrupt behaviour in these markets was still occurring in the UK up until 2014, long after the Libor, IRSA and PPI revelations.

The market police state

Many in the room at the Mansion House were expecting the big announcement to focus on concessions on the bank levy. The expectation – with half an eye on HSBC’s announcements (read: veiled threats) earlier in the week – was that the chancellor might cede some ground to the largest banks. Instead though, the ominous silence on the bank levy and the tough-talking approach reinforce an important message: that the state is no longer willing or able to turn a blind eye to irresponsible banking.

Bankers are in need of a PR boost. Dominic Lipinski / PA Wire/Press Association Images

What is most noteworthy in the latest review is that it shows the Conservative government – known for its strong stance on welfare cuts and typically labelled a business-friendly party – is also taking a tough stance on the UK’s biggest industry, financial services. But this is not as surprising as it might appear. The same principles that underpin the Tories’ position on the welfare state also underpin their take on individuals who commit fraud and cheat in the financial services industry.

The Conservatives are fulfilling a role assigned to them by classical, liberal thinkers such as Adam Smith – that of a market police ensuring the “better” functioning of the market mechanism itself and maintaining the legitimacy of commercial society. This is because, in the mind of the Conservative government, it is not simply “free-riding” benefit claimants which threaten the market mechanism, but the collusive behaviour of individual bankers as well.

Ultimately, the Fair and Effective Markets Review is more than just another piece of clever political rhetoric. It is being backed up by genuine changes in the regulatory approach to anti-competitive behaviour in the financial services industry.

The hope is that, gradually, the culture of banking will indeed change and legitimacy and credibility can be restored to the banking system. But, as some commentators have also noted with some concern, the UK’s unhealthy addiction to cheap consumer credit, high levels of mortgage borrowing, and consumption-led recoveries, means that Britain’s financial worries run far deeper than just the behaviour of a few “bad apples” in the banking industry.

Author – Huw Macartney – Lecturer in Political Economy at University of Birmingham

Real Wages Show US Economy is Stronger Than You Think

From The Conversation. Last month’s US employment report, released on Friday, contained a lot of good news.

First, monthly jobs growth exceeded expectations, as employers hired 280,000 people. Second, the labor force participation rate ticked up, indicating that people who had stopped looking for work were becoming more optimistic about finding a job and thus had resumed their search for one.

Finally, average hourly earnings for all production and non-supervisory workers in the private sector grew by 2%, compared with May 2014.

Some people may question why wage growth of 2% would be considered good news. The reason is there was no rise in prices over that period, so the average real wage also grew by about 2%. And it is the real wage, rather than nominal pay without accounting for inflation, that ultimately determines the living standards of the American worker.

While the first two highlights from the jobs report are indeed good news, this last one might be its most important takeaway – though it’s been true for a few months now. We’ve been reading articles for years about how stagnant wages have been without focusing on the impact of the lack of inflation. In other words, while we’re not making a lot more money, it should feel like more because consumer prices have barely budged since the financial crisis – by that measure, wages for most workers are the highest they’ve been in decades.

This matters because it suggests the economy is in better shape than we think and may be what the Federal Reserve has in mind as it considers raising rates this year, with many (including the International Monetary Fund) urging the central bank to wait until 2016.

One of the biggest risks, however, concerns productivity, which is truly stagnant. That and take-home pay are highly correlated, so if productivity doesn’t pick up, the rise in real wages may well evaporate.

The real wage story

The consumer price inflation data for May will not be released until later this month, so the balance of this essay will focus on the real wage rate in the private sector through April – although I would not expect the story to change once we can evaluate the latest data. (Hourly wage data for government workers are not available.)

I would also like to focus on the economic prospects of middle- and lower-income workers, so I will be looking at the earnings of those in production and non-supervisory roles. This group accounts for 82% of all private sector workers, who on average earned US$20.91 an hour in April.

The average hourly real wage for this group since 2007 is shown below (converted to April 2015 dollars). The shape of this graph undoubtedly will surprise many readers given the widely held believe that the middle class has been falling behind economically.

Real wages are now the highest since 1979. Bureau of Labor Statistics

The average hourly real wage did decline during the “Great Recession” and again in 2011 and 2012, but since falling to its recent low of $20.17 in October 2012 it has increased, first at a modest pace and then more rapidly since September as price inflation disappeared.

Perhaps even more surprising for most people is that the average real wage for these employees is now at the highest level since March 1979, although it is still 8.2% below the all-time peak ($22.27) reached in January 1973.

The average real wage for middle-class workers declined during the second half of the 1970s, the 1980s and the first half of the 1990s, reaching a low of $17.97 in April 1995 (data go back to 1964). Since then, wages have tended to slowly increase, with the largest gains when price inflation disappears and the greatest losses occurring when it spikes upward.

Widespread gains

That brings us back to the most recent figures. During the 12 months through April, average hourly real earnings for production and non-supervisory workers increased by 2%. These wage gains are fairly widespread among industries, as is shown in this table.

Real wages are up across the board over the past year through April. Bureau of Labor Statistics

Moreover, the greatest wage gains occurred in some of the lowest-wage industries: in retail trade (up 2.3%), accommodations (4.6%), full-service restaurants (4.7%) and fast food restaurants (3.7%). Clearly some of the lowest-paid workers in America have enjoyed some very substantial real wage gains during the past year.

Real wage gains have also far outstripped productivity gains. From the first quarter of 2014 to the first quarter of this year (most recent data), labor productivity in the non-farm business sector increased by only 0.3%, compared with real wage growth of 1.9% for private sector production and non-supervisory workers over the same period.

The poor rate of productivity growth has been a feature of the current economic recovery. Over the past five years, from the first quarter of 2010 to the first quarter of 2015, output per labor hour has increased by only 2.8%, or 0.6% per year. Over the long run, productivity growth puts a cap on the maximum rate of growth in the real hourly wage rate – meaning if productivity doesn’t start rising, neither will wages.

Why real wage growth is poorly understood

So why are people so convinced that middle- and low-wage workers have been losing ground?

Many people point to the fact that the real hourly wage is less than it was in 1973, but that reflects the decline that occurred between 1973 and 1995. Since then, the average hourly wages have been on a slow upward trend, averaging 0.76% per year – not much, but positive all the same. And as I’ve shown, those gains accelerated in the past year year, with even larger ones in lower-wage industries.

Perhaps the recent wage gains have yet to sink into people’s consciousness, and thus their assessment of the economy will shortly improve. Also, millions of people are still unemployed or have dropped out of the labor force, and their income has not benefited from the increase in average wages.

Or perhaps people are unhappy because they are comparing their financial situation with higher-income households, who have done even better, although income inequality is only slightly worse than it was in 2000, when the middle class seemed much happier (see the excellent work of Berkeley’s Emmanuel Saez).

Or maybe it’s something as simple as our spending desires outpacing the growth in the real wage rate. People clearly were spending a lot of borrowed money through 2007, when the financial crisis sharply curtailed many people’s ability to borrow and spend.

What I do know, however, is that unless productivity growth improves, the real wage gains that the data show will prove fleeting. And then we really will be in a world of hurt.

Author – Donald R Grimes, Senior Research Associate, Institute for Research on Labor, Employment and the Economy at University of Michigan

Greece Must Accept Reform Proposals Before Time Runs Out

From The Conversation. The Greek government and its international creditors remain at an impasse over the reforms Greece must accept to receive the bail-out it needs to sustain itself in the coming months. The decision to postpone its June 5 IMF debt repayment and reject a set of reforms put forward by the EU Commission president, Jean-Claude Juncker has sparked debate about Greece’s ability to honour its commitments to international creditors.

The back-and-forth exchange of proposals continues, with the Greek prime minister, Alexis Tsipras – now a regular fixture in Brussels – meeting his French and German counterparts today. The need to agree becomes increasingly important for both Greece and the eurozone as the days pass. The current bail-out deal runs out at the end of June and without the further €7.2 billion from the EU and IMF, the Greek government runs the risk of not being able to sustain itself.

Though time is running out, I believe they will eventually strike an agreement. What it will look like, however, is rather opaque. In light of Syriza’s tactics so far and the weakness of Greece’s position, the need to accept what its creditors are offering is increasingly the only solution.

Punching above its weight

When Syriza came to power last January, it promised to deviate from the path of austerity and renegotiate the bail-out programme. It was truly punching above its weight. But in the context of the Greek population having suffered prolonged periods of austerity with no real signs of recovery, it rode the spirit of populism and promised that it could deliver an alternative programme.

A proposition that scrapped austerity, however, has not come to fruition. In fact, the Greek government has not been able to implement large sections of its electoral agenda – mainly due to a lack of funds, but also because the new government needed breathing space as new and inexperienced political actors came to the forefront.

Ultimately, amateur handling of domestic policies and international negotiations by prominent government ministers, such as the finance minister, Yanis Varoufakis, and the foreign minister, Nikolaos Kotzias, internal disagreement over where to focus their precious few resources and an over-reliance on the perceived charisma of Alexis Tsipras have left the government with little to show for its efforts so far.

Charisma can only get you so far. EPA/Yannis Kolesidis

Negotiations with creditors have not managed to turn European partners in favour of the Greek government’s positions. Instead the episode has demonstrated a further demise of the country’s already tarnished image as an unreliable and stubborn partner. Recent statements by high-level EU officials demonstrate well the frustration over the inability of the Greek government to deliver concrete and realistic solutions.

Political game playing

So where does this state of play leave the Greek government? As time is running out and the country’s economic position deteriorates, it is expected that the range of available alternative measures will diminish. Some of the reforms Syriza is proposing on pensions and privatisation require significant time to implement and yield the necessary economic results. Greece does not have that luxury.

There is a strong game of political communication taking place in front of the general public. Not only is Syriza trying to hold together its political mandate and appease a Greek electorate which vested its hopes in the party, but it is also up against internal opposition within the Greek parliament. This has become progressively louder and more visible – arguing for example in favour of a referendum of the proposed agreement with the EU.

Greeks are hoping for a speedy resolution. EPA/Orestis Panagiotou

Nevertheless, the Greek government under Syriza has not received a mandate from its electorate to take the country out of the eurozone. Thus, Syriza is not expected to go head to head with the EU on a full rupture of relations, something it will become extremely difficult to justify domestically.

Meanwhile Europe is trying to hold firm and press Greece to meet its bail-out obligations – to maintain the cohesion of the eurozone and protect the rest of the EU. At the same time, leaders (including Angela Merkel and Francois Hollande) also need to justify their decisions to their own domestic electorates, who are becoming increasingly uneasy.

For all the anxiety, the solution is crystal clear. In order for Greece to move forward, the Greek government needs to take up the opportunity being offered it, accept the political cost domestically and help return the international dignity and standing of the country.

Author Theofanis Exadaktylos Lecturer in European Politics at University of Surrey