The RBA published a paper on The Decline in Wage Growth. In real terms wages are static or falling for many, and we note from our own surveys that as a result, households are under increasing stress, because costs of living continue to rise. In fact the recent cuts in the mortgage rate as the cash rate has fallen, as effectively got people off the hook. This would reverse quickly if rates started to rise, because the average mortgage is bigger now, and held for longer. But whats behind the decline? We summarise the discussions.
The rate of wage growth has important implications for the macroeconomy. Wages are the largest source of household income and the largest component of business costs, and so have significant implications for consumer price inflation. Wage growth has declined markedly in recent years to the lowest pace since at least the late 1990s, according to the wage price index.
Wage measures with a longer history suggest that this has been the longest period of low wage growth since the early 1990s recession. Across these measures, the rate of annual wage growth has declined to around the pace of inflation, about 2–3 per cent. The slowing in wage growth has occurred alongside faster growth in labour productivity. This has also helped to moderate growth in labour costs for firms, beyond the impact of lower wage growth. Accordingly, growth in the labour cost of producing a unit of output (unit labour costs, or ULCs) has also declined markedly since 2012. Indeed, the level of ULCs has been little changed for more than three years – the longest such period since the early 1990s.
Even accounting for temporarily lower inflation expectations, real wage growth from the perspective of consumers has declined markedly, to around zero.
The recent low wage growth has not been unique to Australia. Internationally, wage growth has been lower than forecast for several developed economies in recent years, including some where labour markets have tightened considerably. Various factors have been proposed to explain this weakness, including secular trends that have been in place for some time and have also resulted in a general decline in the labour share of income. However, the decline in wage growth in Australia stands out, with the extent of the forecast surprise for Australia particularly large in the context of OECD countries in recent years
Several factors appear to explain much of the decline in Australian wage growth. There has been an increase in spare capacity in the labour market, and expectations of future consumer price inflation have declined to be a bit below average. Inflation in output prices in recent years has been particularly subdued, in large part owing to the lower terms of trade. More generally, the decline in the terms of trade and fall in mining investment in recent years mean that the economy requires a lower ‘real’ exchange rate, which has been in part delivered by low wage growth. A statistical model indicates that these factors do not fully explain the extent of decline in wage growth, suggesting that other factors, such as an increase in the flexibility of wages to market conditions, may also have contributed.
A range of related factors appear to explain much of the decline in wage growth in Australia in recent years. Below-average growth in economic activity has translated into subdued growth in labour demand, which has resulted in an increase in spare capacity in the labour market. At the same time, expectations for consumer price inflation have moderated to be below average. The decline in the terms of trade and falls in mining investment appear to have played a particularly important role, weighing on economic activity and placing pressure on firms to contain costs. This has partly unwound the relatively strong inflation in Australian unit labour costs over the period of the mining boom, which was part of the economy’s adjustment to the domestic income boost from the higher terms of trade. Altogether, the result has been an adjustment in Australia’s relative labour costs, improving cost competitiveness against other advanced economies. In effect, this has assisted in bringing about some adjustment of the real exchange rate. Statistical estimates suggest that these factors explain much, but not all, of the episode, meaning there may also have been some other forces at play including an improvement in the flexibility of wages.
While a large wage adjustment has taken place, wage growth is widely expected to remain low. Evidence from the Bank’s liaison with businesses, alongside surveys of firms and union officials, suggest that the general pace of wage growth is not expected to pick up over the year ahead. One further factor that may continue to weigh on wage growth is a ‘pent-up’ adjustment. Reports through the Bank’s business liaison in recent years have indicated that many firms and employees have been reluctant to bargain for wage growth below expected inflation of 2–3 per cent. Accordingly, wage outcomes of 2–3 per cent have been relatively common over the past couple of years among liaison contacts. Outcomes lower than this, which would imply a fall in real consumer wages, are generally seen to have a negative effect on worker morale and productivity, as well as on the retention of quality staff. So while the decline in wage growth has been large, it might have been larger still if not for this element of rigidity in real wage growth. Accordingly, a degree of ‘pent-up’ downward pressure on wage growth might remain for a time, even if labour market conditions more generally were to improve.
