Australian wages underperforming current labour market conditions: Justin Smirk
GUEST OBSERVER
There has been a marked improvement in the Australian labour market with a lift to total employment, of which the largest share has been full-time, and a drop in the unemployment rate.
Despite a clear tightening in labour market conditions we are yet to see a lift in wage inflation.
Firms do not appear to be under pressure to lift wages to attract staff while rising underemployment and relatively high unemployment expectations suggest household are not confident enough to bargain for stronger wage rises.
Since 2015 wages have underperformed the historical relationship but this underperformance is less clear in Victoria. The relationship is still broadly holding in SA.
It is not yet clear if we have seen a shift in the curve or a breakdown in relationship. Regardless, we expect any lift in wage inflation to be modest and gradual.
A meaningful improvement in the labour market conditions.
The Australian labour market went through a soft patch from August to November in 2016 when the average gain in employment was a paltry 2.2k per month. So far in 2017 there has been a distinct uplift in employment. In the three months to May, total employment gained 141.1k, or an average of 47k per month, lifting the annual pace from 0.9%yr to 2.0%yr. Employment growth is now more in line with our preferred leading indicators, the various business survey’s and household demand.
Taking the Labour Force data at face value, you could argue there has been a material tightening in labour market conditions. The quarterly unemployment rate peaked at 6.2% in 2015 Q3 then fell steadily to average 5.7% for the three months to May 2017, pointing to a material tightening. And it is not just unemployment that is pointing to an improvement.
We have also seen a recovery in full-time employment. Through 2016, full-time employment fell 35k as part-time employment rose 127k. In 2016, all of the growth in total employment came from the significant lift in part-time employment. In the year to May 2017, full-time employment rose 148k for a 1.8%yr pace, so full-time employment growth is now exceeding growth in the working age population, the first time it has done so since February 2016.
And yet wages continue to languish at record lows.
Normally when you observe a tightening in the labour market, you would expect to see an increase in wage inflation. But we have not seen this with wage inflation, as measured by the Wage Price Index (WPI), holding at a historical low of 1.9%yr. One measure of tightness is to compare the unemployment rate to the rate unemployment would be if the economy was at full employment.
The RBA estimates a NAIRU, or Non-Accelerating Inflation Rate of Unemployment, to be currently around 5.0%. So while there is still a gap, the unemployment rate has moved closer to the NAIRU representing a tightening of the labour market.
Westpac uses a labour gap which is the difference between unemployment and trend unemployment. Historically the labour gap had a two quarter lead to wage inflation. In the year to the June quarter, the labour gap averaged +3ppts; the last time it was this positive was back in September 2012 when wage inflation (as measured by the Wage Price Index) was running at a 33⁄4%yr pace. Wage inflation printed 1.9%yr in the March quarter of 2017.
Employers do not feel under pressure to bid up wages.
Another measure of slack is the “is labour easy or hard to find” question from the Westpac/Australian Chamber business survey. However, whereas from early 2016 the labour gap was pointing to a tighter labour market conditions, this index suggested labour was still relatively easy to find. While it may have become bit harder since, it is still consistent with a neutral response (neither easy nor hard to find) and as such it does not appear that employers are under any pressure to bid up wages.
Underemployment has lifted as job insecurity holds a relatively high level.
Could employees’ employment insecurity have a role to play? Since late 2014, unemployment expectations from the Consumer Sentiment survey has been relatively weaker than its historical relationship with unemployment so maybe workers aren’t confident enough to bid up wages.
There does appear to be some basis for this relatively high level of job insecurity. The ABS has an alternative labour market measure known as underemployment, which is the share of labour that while employed are willing and able to work more hours. From 2015 H2, while the underemployment rate fell from a peak of 6.1% to 5.5%, the underemployment rate rose from 8.3% to 8.8%, with an 8.9% peak in early 2017.
The RBA noted in the February Statement on Monetary Policy that since the 1980’s, the upward drift in underemployment can be explained by the rising share of part-time employment. It also noted that “underemployment rates are higher among groups that have a higher share of part-time employment, such as females, younger workers and older workers”, so as their share of employment rises so too does underemployment.
We would, however, counter with two observations.
Firstly, in the year to May, full-time employment growth accelerated while part-time employment eased, yet underemployment lifted from 8.4% to 8.8% suggesting a genuine broadening in underemployment rather than a compositional shift.
Secondly, combining unemployment and underemployment generates underutilisation, the broadest measure of labour market slack. We have found that this measure has a better relationship with wage inflation than either unemployment or underemployment by themselves. But this still leaves the observation that, since 2015 there has been an underperformance of wage outcomes to underutilisation.
State data reveals some interesting divergences from the national average.
How long can we divert from this historical relationship? To answer we turn to the state labour markets. In NSW the unemployment rate in May was just 4.8%, well below the national average and below the RBA’s estimate of the NAIRU. From the end of 2015, NSW’s unemployment fell from 5.3% to 5.1% (March quarter average) and yet underemployment lifted from 7.5% to 8.0% boosting underutilisation from 12.8% to 13.1%. However, even this softening in underutilisation does not explain the on-going weakness in private sector wage inflation, which printed just 2.0%yr in the March quarter. If wage inflation held the historical relationship with underutilisation, it would just under 3.0%yr.
We should also note that NSW also has the lowest participation and employment to population ratio for any mainland state outside of SA. These factors put into perspective the fact that NSW low unemployment is not a strong indicator of the overall tightness of a labour market.
Compare this with Victoria, where wages have kept something of a tighter relationship with underutilisation. At 15%, underutilisation suggests wage inflation should be running at just under 21⁄2%yr. The state’s WPI printed 1.9% in March which is a smaller wedge to underutilisation than in NSW. Victoria also has a higher rate of unemployment than NSW (6.1% vs. 4.7%) and underemployment (8.6% vs. 8.0%) but that does not necessarily mean Victoria has a weaker labour market.
Total employment has grown just under 4%yr pace in Victoria while in NSW it has grown less than 1%yr. The higher rate of underemployment and unemployment in Victoria reflects that states faster rate of population growth combined with a higher rate of participation (for both males and females). Victoria is also the only state where you can observe a trend rise in male participation since 2014. Other states may show something of a levelling out, or a recovery, since late 2016 but all declining male participation preceding. It has also recently seen the largest jump in female participation for any state.
In Qld, wages are below the curve with an underutilisation rate around 14% pointing to wages growth of at least 3.0%yr. Wages in that state are currently growing at 1.8%yr, a significant wedge to historical outcomes. Male participation has started to lift again in Qld so even if we do see the underutilisation/wage relationship return to the curve, will it be driven by rising wages or rising underutilisation due to rising participation?
WA is interesting in that while wage outcomes since 2015 are clearly below the longer run relationship with underutilisation, the shape of the relationship still holds - that is it appears that the curve has shifted downwards since 2015. This suggests that while the historical underutilisation/wage relationship would put wages growth around 2%yr (for a 15% underutilisation rate) actual wages growth of just under 1% appears to be holding a shorter term relationship since 2015.
Of all the states SA is holding the tightest long-term relationship for underutilisation/wages. An underutilisation rate of around 17% would normally see wages grow at 21⁄2%yr; the WPI rose 2.0% in the year to the March quarter. We have been watching the relative out performance of wages in SA despite the relatively high rates of unemployment (and underemployment) and wonder if this reflects the relatively more significant contribution manufacturing makes to that state's economic activity compared to the other states.
It is not clear if curve is shifting or breaking down.
The significant underperformance of NSW wage inflation does raise questions not just on the specification of a NAIRU but whether the NAIRU is still a useful concept. It is possible that the breakdown in the NAIRU is due, at least in part, to the Australian economy’s shift away from goods production to services provision, which is more dominate in NSW than it is in Vic and SA, and as such the breakdown may be temporary.
The downward shift in the WA curve suggests this may be the case as that state has seen it economy experience a rapid and significant shift away from the resources sector. But the significantly different participation rates between the states may also point to something more structural. As such, to assume that a falling unemployment rate will drive an uptick in wages may lead to an overstatement of the outlook for wages, household income growth and thus inflation and consumption. Currently Westpac is taking a cautious view that while wage inflation may have found a base, any uptick will be modest and gradual.
Justin Smirk is senior economist, Westpac Group and can be contacted here.
