Wages Shock And Horror More Nostalgic Than Alarming

Sydney Morning Herald

Monday July 14, 2008

Ross Gittins Ross Gittins is the Herald's Economics Editor.

The screaming headline, "Wage rise stokes inflation fear", with which one newspaper greeted the Fair Pay Commission's minimum wage decision last week didn't disturb me so much as remind me how far we've come since the bad old days of economic mismanagement.

It's worth remembering that 20 years ago statements along those lines were being made by economists, employers and politicians about once a week.

They had truth then, but have little now.

The pay commission's decision to raise the federal minimum wage - and all the minimum wage rates specified in each award - by $21.66 a week surprised on the high side. The employer groups had asked for a rise of $10 and the ACTU for $26.

But the nation's economists could hardly raise a yawn over the news and even the employer groups' outrage seemed more synthetic than usual.

Why so blase? That divides into two questions. Why did wages growth recede to the back of economists' concerns? Why do economists take little interest in the annual minimum wage adjustment? And while we're at it, why was the pay commission so seemingly generous?

Economists haven't worried much about wages since the early 1990s. That was when, in the aftermath of the last big recession, we returned to low inflation and moved from centralised to decentralised wage-fixing at the enterprise level.

When the inflation rate is about 8 or 10 per cent - as it was during the '70s and '80s - workers need pay rises of a similar magnitude just to maintain the real value of their earnings.

But employers have strong resistance to such seemingly large nominal increases, while economists worry that they tend to perpetuate an inflation rate that's way too high, putting us at a disadvantage to our trading partners (and necessitating a perpetual depreciation in our exchange rate).

Such high inflation rates also distort decision-making (favouring debt financing over equity, for instance) and favour high-income earners over low (because only the rich can afford the professional advice needed to protect the real value of savings).

But when, after battling high inflation for most of the '70s and all of the '80s, the early '90s saw us return to a rate averaging an inconsequential 2 to 3 per cent, economists soon realised they could stop obsessing about wages.

Throughout the Hawke-Keating government's decade-long battle to get inflation under control, growth in real wages was non-existent. But once we'd returned to low inflation, real wage growth of a per cent or two a year became the norm.

This is a strange and important fact, one unions, wage-earners and everyone else need to remember: once you've got inflation back in the zone, workers can get themselves modest but steady real wage rises with little resistance from employers.

Why? Not for any reason the conventional economic model can give you. I think it's a form of "money illusion" - employers have an attitude that 8 to 10 per cent wage rises seem way too high, whereas a 4 per cent pay rise seems quite manageable.

This is money illusion because employers tend to hold these attitudes independent of the prevailing inflation rate. That is, they tend to think in nominal terms, not real terms.

The trick, of course, is that with an inflation rate averaging 2.5 per cent, a 4 per cent nominal pay rise is a real rise of 1.5 per cent.

I wish some enterprising labour economist would check this out, but my impression is that, in enterprise bargaining, an annual rise of 4 per cent has been established as a "norm" - a widely used and accepted compromise between employers and unions, one that doesn't vary with the specifics of the latest inflation rate.

If 4 per cent strikes you as too high, or inflationary, I need to remind you of the "line in the sand" Bernie Fraser drew when he was governor of the Reserve Bank. He said he wouldn't worry too much about aggregate wage growth unless it exceeded 4.5 per cent. (It's noteworthy that, with underlying inflation presently rising and way above the Reserve's target range, economists have been watching the wage growth indicators more keenly than usual. But so far the wage price index has stayed resolutely around 4 per cent.)

Where did Mr Fraser's 4.5 per cent upper limit come from? It's 2.5 per cent for the mid-point of the inflation target plus 2 per cent for the medium-term trend rate of improvement in the productivity of labour (a better figure for that these days would be 1.75 per cent).

The point to note is that whereas wage rises are nominal, productivity is a real, not a nominal, concept. Thus wage increases in excess of inflation don't add to the inflation rate unless the extra exceeds the rate of productivity improvement - a truth employers don't like admitting.

The move to enterprise bargaining is, of course, an important element in the lack of concern about wages growth. It gives individual employers some scope for seeking efficiencies in return for real wage rises. And it removes the old bugbear of large (possibly justified) wage rises in one industry flowing on to other industries where they make no sense.

This brings us to the reason economists have lost interest in the Industrial Relations Commission's (and now the pay commission's) annual adjustment of federal minimum wages.

Because of the spread of enterprise bargaining - formal and informal - only about 150,000 workers are reliant on the federal minimum wage and only another 1.1 million or so are reliant on the higher minimums specified in awards, about 14 per cent of the workforce in total.

So whether the annual increase is large or small, it simply doesn't affect enough workers to make it significant at the macro-economic level. Last week's decision, for instance, will put just 0.4 percentage points into (but not necessarily add to) the ongoing inflation rate when it becomes payable in October.

But why the generous $21.66 a week increase this time? That's equivalent to a rise of 4.15 per cent in the federal minimum wage. (If you're wondering why it's such a ragged figure, that's because it began life as an increase in the federal minimum hourly wage rate, which can be adjusted only in whole cents.)

Could it be that the WorkChoices-created Fair Pay Commission is getting with the program of the Rudd Government, whose policy is to abolish it and hand its powers back to the Industrial Relations Commission, rebadged as Fair Work Australia?

No, it couldn't. The greatest influence on the size of the increase is the official Treasury estimate for inflation in the year to June 2008, which is 4 per cent.

Once you know that, and also remember the pay commission's first increase of $27.36 a week in October 2006 was to cover 18 months, whereas its second increase of $10.26 a week in July last year was to cover nine months, you see the successive decisions have been pretty consistent.

The simple truth is there was never any prospect of the pay commission seriously reducing the federal minimum wage in real terms because of the work disincentive this could create because unemployment benefits are indexed to inflation.

But, finally, note that the pay commission's modus operandi can't be called indexation because all the wage rises it grants are flat dollar amounts, not percentage increases.

This means all the increases in minimum wage rates above the federal minimum wage (C14, as it's known in the jargon) will be less than 4.15 per cent in proportional terms. The tradesperson's wage (C10) will rise by 3.52 per cent, while the minimum for engineers (C1B), which few of them actually depend on, will rise by 2.05 per cent. Can't see a lot to worry about there.

© 2008 Sydney Morning Herald

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