Where our are wages?

Australia's nominally poor performance

A recent bulletin article from the Reserve Bank of Australia indirectly highlights what I think is one of the biggest question facing the Australian economy. Mainly where the bloody hell is the nominal wage growth?

The figure below does shows just how much an international outlier we are. 

The United States, Germany, New Zealand and the UK are all experiencing close to record high nominal wage growth coupled with extremely low levels of unemployment. This is quite at odds with Australia’s experience. Our unemployment rate is also at a record low level, but wage growth in Australia has remained incredibly disappointing.

The most recent statistics show that the wage price index is grew at roughly 2.5% over the past year, a rate that is far lower than our peer nations and lower than the rate that should be consistent with our own inflation target. Making cross-country comparisons is always a fraught business, but the global nature of the pandemic and energy shocks combined with the size of the discrepancy is a real (well, nominal) puzzle.

What explains this divergence?

White noise

All economic concepts are measured with noise. While the ABS is the ultimate gold standard in economic statistics it’s not inconceivable that they their official wage price measure is somehow missing the true story of Australia’s labour market. So what do alternative measures of wage growth tell us?

The Reserve Bank of Australia‘s liaison program has a decent track record of predicting private sector wage worth. However their liaison measure seems to indicate that while wages should be a touch higher than what is officially reported the difference is well within historical norms. Even if their liaison reports were exactly right that would suggest a WPI figure of only 3% – still quite disappointing

Wages are coming?

Another explanation is that while wage growth remains low it will rapidly increase in the coming months thus resolving puzzle. I think this explanation should be treated with some skepticism as wage growth has been predicted for awhile but has yet to materialise.

That being said there is some evidence for this hypothesis in the data.

Matt Cowgill at Seek has produced a measure of advertised wages by collating salaries as reported on their platform. This data will naturally be somewhat different to wages across the entire economy as newly advertise positions are not generally representative of the entire labour market, but it is interesting to note that the monthly growth of wages for open vacancies has been trending upwards open the past year. If advertised salaries are leaving indicator for broader wages we might expect wage growth to start to pick up more broadly.

Yet the RBA is still forecasting wage growth to be relatively subdued. The most recent set of RBA forecasts indicate that the wage price index will slowly increase into the 3s next year and they still they don’t expect wage growth to go above 4% over the forecast horizon.

Modelling weaker wages

The standard models central banks use attribute changes in wage inflation to three main sources: the unemployment rate or tightness of the labour market, indexation of wage agreements either formally or informally to changes in price inflation, and expectations of future wage growth. While the use of formal indexation of wage agreements to the CPI has diminished since the 1970s expectations of future price growth are an important input into the wage bargaining process as workers and firms seek to set their real wage.

One possible explanation for Australia’s low nominal wage growth is thus the fact that Australia has experienced lower price inflation over the past couple of years.

The graph below shows headline inflation rates, including forecasts from mid 2022 onwards, produced by the OECD. As of Q2 2022 Australia had the lowest inflation rate compared to peer nations.

This may explain why wage growth has been comparatively so anaemic. Nominal wages have risen by relatively small amounts in Australia in part because the cost of goods have also risen at a slower rate. Given higher price inflation increases workers’ demand for nominal wage rises and increases firms’ ability to pay them, we shouldn’t be surprised that they result in higher nominal wages.

It’s worth noting that even though our inflation rate is lower than our peers, it is still very, very high. On top of the high inflation and tight labour market it is clear that the one-two punch of the pandemic and the energy crisis has lead real wages to fall dramatically across the developed world.

Original Sin

Of course that raises the question of why the overall level of inflation has been lower in Australia in the first place. What is the fundamental cause of the lower inflation of both prices and wages?

My best guess is it this lower inflation was driven by the lower inflation expectations in Australia heading into the COVID-19 pandemic which persisted throughout 2021. According to the Reserve Bank of Australia’s own measure of inflation expectations union leaders and market economists both expected inflation to be below 2% until the second quarter of 2021. By comparison at this time headline CPI in the United States had already reached 5%! Even New Zealand had an annual CPI growth rate of 3.3% at this time.

When choosing between the recent history of persistently low inflation and the first signs of price growth overseas, it seems that many Australians relied myopically on their own personal experience of subdued price growth. This widespread expectation of low inflation meant that the 2022 increase in wages and prices was much more subdued compared to other countries.

In some ways this could be seen as a somewhat lucky break. An large inflationary shock hits precisely when Australia’s inflation expectations were drifting dangerously below their target level. The opposite of when the GFC arrived just as the mining boom causing an inflation break out in 2008.

Low inflation expectations are a great boon to a central bank trying to control an inflationary shock. They help keep inflation close to it’s target even when demand is high and supply chains are disrupted. It is unfortunate that we had to suffer through hundreds of thousands of lost jobs in order to achieve them.