Why there’s no magic unemployment rate to boost Australians’ wages

Although Australia has the lowest unemployment rate in over a decade, wages are lagging behind consumer prices, Jim Stanford* explain why.

with the official unemployment rate now at 4.2% – the lowest since 2008 – Prime Minister Scott Morrison predicted a rate “with a 3 ahead of him this year”.

The Reserve Bank of Australia agrees, forecasting an unemployment rate below 4% in the coming months.

Many economists have been surprised at how quickly employment has rebounded from the effects of COVID-19.

Now they are scratching their heads for another reason.

With unemployment so low, why aren’t wages rising faster?

Real wages down

If something is missing, its price is supposed to increase.

This is according to conventional economics, which treats the price of labor (wages) like any other commodity, from pork bellies to rapid antigen tests.

But there are few signs that this is happening.

Since 2013, nominal wage growth (excluding inflation) has been weaker than at any time since the 1930s, with an average annual growth rate of 2.1% half the typical rate in previous years.

After stalling during shutdowns, wage growth has rebounded – but only at those anemic pre-pandemic rates (up just 2.2% over the past 12 months).

Nominal wages are now well below consumer prices.

Real wages (taking inflation into account) therefore fall – the opposite of what free market theory predicts when unemployment is low.

This result baffles economists who focus on market forces to explain income distribution.

But this is not surprising for those who consider a wider range of structural, institutional and social determinants of wages.

Unemployment can affect wage trends, but not necessarily for the same reasons assumed by market-oriented theories.

But many other factors – including the minimum wage, collective bargaining, the reward system, and even politics and culture – also explain who gets paid what.

Market-based ideas drive policy

A simple market-based understanding of wages has guided government and RBA policy stance for a generation.

Both rely, for example, on the concept of an “unemployment rate without accelerating inflation” (or NAIRU).

This is the lowest unemployment rate that can be achieved without raising wages and inflation.

The two keep changing their estimates of its precise level, with the Treasury’s most recent calculations putting it between 4.5% and 5% in the years before the pandemic.

One of the reasons the estimates change is that the concept is impossible to measure.

Many countries have abandoned this widely criticized concept.

Yet it still underpins Australia’s fiscal and monetary policies.

A softer approach recognizes that wages will gradually accelerate, rather than suddenly take off, as unemployment approaches the estimated unemployment rate without accelerating inflation (NAIRU).

This relationship is expressed graphically in what is called the Phillips curve.

With unemployment falling, wage growth should gradually pick up.

This allows policymakers, particularly the RBA, to try to steer the economy towards a “sweet spot” on the Phillips curve: with wage growth consistent with the RBA’s inflation target.

Nice in theory, not in reality

Unfortunately for both theories, the expected automatic relationship between unemployment and wages is not visible in the real world.

Australia’s unemployment rate has fallen through successive NAIRU estimates (first 6%, then 5%, now 4%) with no signs of an inflationary takeoff.

The Phillips curve also transforms, changing both its vertical position and its shape.

The attached figure plots unemployment against the annual rate of wage growth.

Before 2013, only a weak relationship was visible between wages and unemployment.

Since 2013, the curve has shifted downward and flattened, with virtually no discernible link between unemployment and wages.

Other factors at play

The only way to explain this apparent anomaly is to look at the broader structural determinants of wages.

No economy just lets go of the market to determine how much people get paid.

Regulations, institutions and processes affect the distribution of income between classes, professions and jobs.

They can be used to create a fairer distribution.

Or they can be used to reward certain groups and suppress income from others.

Either way, it is institutions and policies – fundamentally shaped by politics and power – that determine the distribution of the economic pie.

Circumstances now provide a telling insight into the importance of these institutions – and how dramatically they have changed.

The attached table compares current labor market outcomes and institutional settings to those that prevailed the last time unemployment was below 4%.

Fifty years ago, nominal wages rose vigorously, at more than 10%.

Inflation was high (almost 6 percent) but real wages continued to rise.

Today, inflation is half that rate, but wages are falling relative to prices.

This is due to a day and night contrast between yesterday’s and today’s labor market institutions.

The minimum wage is now much lower compared to the average.

The rewards system has been restructured to serve only as a safety net, rather than driving improvements in wages and conditions.

Unions and collective bargaining have been decimated, with strikes almost non-existent.

The bargaining power of workers has been further eroded by the spread of part-time work, casual jobs and other non-standard jobs, including digital contracts.

Fifty years ago workers had the institutional power to secure decent wage increases – even when unemployment was relatively high.

This power has been regularly and deliberately stripped away through privatization, the suppression of union activity and the liberalization of precarious work.

Higher wages would strengthen household finances, support consumer spending and ensure a fairer distribution of income.

But there is no magic unemployment rate that will produce this result.

If we want higher wages, we must earn them through deliberate wage-raising policies.

*Jim Stanford is Economist and Director, Center for Future Work, Australia Institute; Honorary Professor of Political Economy, University of Sydney.

This article first appeared on theconversation.com.

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