While the growth rates of labour demand and supply have both been weaker over the past couple of years, we know that the former has been more significant than the latter. The fact that labour supply has not been constraining employment growth is evident in the rise in the unemployment rate and the substantial decline in the growth rate of wages over that period (Graph 12).
The slowing in wage growth is clear also in the leftward shift in the distribution of wage growth across individual firms (Graph 13). The data shown here are from the NAB business survey. This is also consistent with the Bank’s liaison which suggests that wage outcomes of more than 4 per cent have become far less common than was the case a few years ago. Indeed, outcomes of 2–3 per cent are more common than 3–4 per cent. Slower wage growth has also been helped by inflation expectations remaining contained.
The implications of a slowing in labour demand (relative to supply) depend significantly on the responsiveness of wages. Changes in demand will have less of an effect on employment and output if wages respond sooner and by more than otherwise. In this respect, the more flexible labour market in comparison to earlier terms of trade booms has been helpful. This flexibility allowed for a rise in relative wages to encourage labour into resource and resource-related activities during the run-up in mining investment, without this leading to a large rise in the growth rate of wages across the economy more broadly. The same flexibility is helping as the terms of trade and mining investment turn down.
Indeed, the decline in wage growth of late has been particularly pronounced in mining and business services, but it is evident elsewhere (Graph 14). The move from the investment to the production phase of the mining boom is freeing up and will continue to free up labour to move back into the non-resource sectors of the economy. This has weighed on wage growth across the economy and is likely to do so for a while yet.
The slowing in wage growth across all industries has meant that firms have experienced relatively slow growth in their labour costs. This is more striking after accounting for the growth in the productivity of labour, which as I’ve already noted has picked up somewhat compared with the pace we had become accustomed to over much of the 2000s. Over the past year and a half, the growth in nominal wages has been matched by growth in labour productivity. As a result, there has been no increase in the cost of labour required to produce a unit of output.
In turn, slower growth in labour costs is having a beneficial effect on international competitiveness. The link between labour costs and competitiveness can be illustrated by a measure of the real exchange rate based on unit labour costs (the real trade weighted index (TWI) in Graph 15). This tells us about the labour cost of producing a unit of output in Australia relative to the cost of doing so in our trading partners (both measured in equivalent currency terms). Over the decade to 2011, the real exchange rate appreciated significantly, consistent with the rise in the terms of trade and the mining investment boom. Much of that occurred via the nominal exchange rate, which appreciated by a little more than 50 per cent over that period. But part of the adjustment occurred via a pick-up in the pace of wage growth, at a time when labour productivity growth was relatively slow. Hence, nominal unit labour costs in Australia increased by around 25 per cent relative to our trading partners over this same period, contributing noticeably to the decline in competiveness (outside of the resources sector, which benefited from much higher commodity prices).
Now that process is beginning to change course. A decline in the real exchange rate is one important way in which the economy can adjust to the decline in the terms of trade and the transition to the production phase of the mining boom. Over the past year, we’ve seen a noticeable decline in the nominal exchange rate, although it still remains high by historical standards, particularly given the further decline in commodity prices in recent months.
At the same time, Australian unit labour costs have stopped rising relative to our trading partners and even declined just a little since mid 2012. This is part of the adjustment to the decline in commodity prices and will assist the non-mining economy regain some competitiveness and generate employment growth as demand for labour in the resources sector turns down. Adjustment via slower wage growth and stronger productivity growth may not contribute as much nor as quickly to a real depreciation as might be expected from a decline in the nominal exchange rate. However, it is still preferable to the alternative of little or no adjustment in the growth of unit labour costs, which would come at the expense of more unemployment and the associated economic and social costs.
Look at the last chart and the magnitude of the correction ahead for the real exchange rate. There are no rate rises coming.
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal.
He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.
