Would higher wage growth help the Australian economy?

Matthew Peter, Chief Economist 

This week, we received key data on the Australian labour market. While employment growth remained robust and the unemployment rate remained only moderately high (and stable) at 5.6%, wage growth remained anaemic at 1.9%.

From the demand side of the economy, weak wage growth limits growth in household incomes and, hence, the pace of consumer spending. As consumer spending accounts for around 60% of GDP, tepid growth is a significant headwind to economy-wide demand. In addition, given the fall in the savings rate, household debt is accumulating at a more rapid pace than household income. Hence, the Australian household’s debt burden is rising at a faster pace than its ability to service the debt; an unsustainable situation. Increasingly, faster wage growth is being proposed as a panacea to the dual ailment of weak consumer spending and deteriorating household finances.

Most obviously, faster wage growth allows for a pick-up in consumer spending without the need for a drop in the savings rate and the sustainable accumulation of debt. Faster income growth also increases the ability to service debt, thus improving household finances. The call for faster wage growth has come from obvious quarters, such as the union movement, and less obvious quarters, such as the Reserve Bank of Australia.

However, faster wage growth also has economic consequences for the supply (or cost) side of the economy; most obviously, an increase in costs to businesses. To the extent that wage growth lifts inflation, faster wage growth can also be expected to cause the RBA to increase interest rates, with the impact of also appreciating the currency. Higher wage costs, AUD and interest rates hurt the earnings of those businesses less able to pass on higher costs to their customers.

As higher wages boost the purchasing power of Australian residents but not foreign consumers, higher costs tend to hurt export and import-competing businesses more than businesses that don’t face international competition. Currently, there is one employer that is lifting wage growth to their employees. That employer is the government.

Public sector wage growth is currently running at 2.4% per annum cf private sector wage growth, which is running at an annual rate of just 1.8%. However, the increase in wage costs to public sector employees does not come without cost. In a backdrop of a fiscally constrained government sector, higher wage growth of public servants is inevitably paid for in either a higher charge for user-pay services or by higher taxes. Higher charges for user-pay government-provided services for health coincides with the fastest rate of annual wage growth of any sector, private or public, of 2.8% for government employed health workers.

Looking beyond health, those sectors that are currently experiencing robust growth in the economy such as tourism, educational services and agriculture are export oriented industries have benefited from the 30% devaluation in the currency and a fall in average annual wage growth from a peak of 4% to 5% during the peak of the mining boom, to around 2% currently. Relative to the trajectory of these industries’ cost bases four to five years ago, their cost base is lower by around 35%.

During the period of the construction phase of the mining boom, when wage growth, interest rates and the AUD were rising, it was precisely these industries that were crowded out by a cost squeeze, which are now reviving due to the reduction in costs. Higher costs to these industries, in the form of higher wage growth, higher AUD or higher interest rates threatens to undermine their recoveries.

What, then, can be done to speed up the recovery to trend in the Australian economy? In our view, the headwinds to Australian growth are: government and household debt overhang and excess supply in the housing market. Orderly corrections in indebtedness and in the housing market requires a continuation of low interest rates.

With domestic demand constrained by household and government austerity as debt/income ratios are stabilised, the task of supporting growth in the Australian economy will fall increasingly on industries that source their demand from abroad or are able to attract domestic spending away from imports. Until the household and government sectors are in a position to increase spending to at least trend levels, our trade exposed industries will require muted wage growth and a low AUD if they are expected to underpin the Australian economy.

Table 1: Financial market movements, 10 - 17 August 2017

Equity index

Level

Change

10-yr government bond

Yield

Change

Foreign exchange

Rate

Change

S&P 500

2,430.0

-0.3%

US

2.19%

-1.2 bps

US Dollar Index (DXY)

93.62

0.2%

Nikkei 225

19,702.6

-0.1%

Japan

0.05%

-0.9 bps

USD-JPY

109.57

0.3%

FTSE 100

7,387.9

0.0%

UK

1.09%

0.5 bps

GBP-USD

1.287

-0.8%

DAX

12,203.5

1.6%

Germany

0.43%

1.1 bps

EUR-USD

1.172

-0.4%

S&P/ASX 200

5,779.2

0.3%

Australia

2.64%

-1.4 bps

AUD-USD

0.789

0.1%

Source: Bloomberg


Economic Update

United States

Inflation rises but continues to disappoint in the US
  • Headline CPI inflation rose slightly in July but by less than the market expected, continuing a run of soft inflation prints in the US. Consumer prices rose 1.7% from a year earlier, an increase from 1.6% in June after four months of declining inflation, while prices rose 0.1% in monthly terms after remaining unchanged in June. Core CPI, which excludes food and energy prices, rose a lacklustre 0.1% in July for the fourth consecutive month. Despite FOMC members initially identifying the weakness in inflation over the past months as transitory, minutes from the July meeting released earlier in the week suggests that the committee is becoming increasingly concerned and will be monitoring the situation closely going forward.
  • Retail sales in the US grew by 0.6% over July as strong growth in auto and other discretionary sectors boosted sales the most since December. June’s print was revised to 0.3%, up from the disappointing -0.2% initial estimate. Excluding sales at auto, gas, food services and building and supply stores, ‘control’ retail sales also grew by a strong 0.6% over the month. Control sales for June were also revised upwards to 0.1% from the previous -0.1% estimate. 

Euro area / United Kingdom

Labour market improves further in the UK as inflation stabilises
  • Industrial production within the euro area declined by 0.6% over the month of July, down from a 1.2% rise in June. This was on the back of a broad-based decrease in output from most sectors, with the exception of energy production. 
  • Despite prices falling by 0.1% from June to July, headline inflation in the UK remained unchanged at 2.6% relative to a year earlier. A decrease in energy prices in July was partially offset by a rise in food, clothing and household good prices.
  • Labour market conditions within the UK improved over the month July, with the unemployment rate edging lower to 4.2%, down from 4.3% in June. Wage growth, a good indicator of labour market tightness, picked up a little over the three months to June, with average year on year earnings (excluding bonuses) growing 2.1%, up from 2.0% over the three months to May.


China / Japan

Economic growth in Japan jumps in Q2 on strong domestic demand
  • Japan’s economy grew at the fastest rate in more than two years in Q2, driven by robust growth in private consumption and business investment, and despite a contraction in net exports. Real GDP grew 1% in the quarter, the sixth consecutive quarterly expansion and the longest run of uninterrupted quarterly growth in a decade. The quarterly growth was much stronger than the 0.6% pace expected by the market. 
  • In contrast, Chinese economic data disappointed during the week. Industrial production, urban fixed asset investment and retail sales all grew by less than expected in July, after economic growth surprised on the upside in Q2. Industrial production grew 6.4% y/y in July which, while down from 7.6% growth in June, is still a faster rate of growth than recorded over most of 2016.

Australia / New Zealand

Jobs growth in Australia fails to spur higher wage growth
  • The unemployment rate in Australia fell to 5.6% in July from an upwardly-revised 5.7% in June. Almost 30k jobs were added in the month, driven by part-time employment, as full-time jobs fell after two months of strong growth. Despite a labour market that continues to add jobs at a robust rate, wage growth continues to remain lacklustre at 1.9% y/y in Q2, unchanged from Q1.



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