Australia’s top economist has detailed his economic ‘nirvana’. But can Australia achieve it?
Philip Lowe has laid out his economic nirvana. Will Australia make it, or succumb to its pre-COVID malaise? Photo: TND
What does an ideal Australian economy mean to you and your family?
For many Australians, affordable housing, well-paid work, stable prices and enough left over to save for a comfortable retirement top the list.
But beach holidays and hobbies might also factor in.
I’m asking you to reflect on this because Australia’s top economist gave a remarkable insight into the ideal economy during a Q&A earlier this month.
Reserve Bank governor Philip Lowe had just finished delivering a broad speech on the Australian economy in rural New South Wales when the topic of what economic success looks like in Australia came up.
“Let me describe my central bank nirvana to you,” Dr Lowe began.
“It’s an inflation rate that’s averaging 2.5 per cent, labour productivity growth at 1.5 per cent … wages growing at 4 per cent [annually] and full employment,” he said.
“That’s where I would like to see us get to.”
Dr Lowe’s answer was remarkable not because those are controversial measures of economic success – in fact they are quite the opposite – but because Australia hasn’t achieved them in many decades, or perhaps never has.
Underlying annual inflation has averaged less than 2 per cent over the past decade (below the RBA target), wages growth is running at a paltry 2.2 per cent yearly, and labour productivity rose just 1.1 per cent in 2020-21.
And the jobs market, though improving, is still hosting an estimated 637,000 people out of work – obviously very far from full employment.
Overcoming the ‘dog days’
You might be thinking: ‘Of course, the economy is in rough shape, we’ve just come through more than two years of dealing with COVID-19, right?’
Well, the truth is, most of this economic malaise occurred before COVID-19.
In the years before and after the mining investment boom, Australia’s economy was plagued by low growth, stagnating living standards and an inability to provide well paying and secure work to everyone who wanted it.
And we aren’t the only ones muddling through.
Other economies like the United States, the United Kingdom and much of Europe have suffered a similar fate.
The question economists like Dr Lowe are now asking is whether the disruption caused by the pandemic and the associated policy support from the federal government and RBA during that time will be enough to shake off this malaise and position Australia for a new economic boom.
In other words, will Australia build back better in 2022, or fall back into the same stagnation that has cheated two generations of workers?
Despite knowing where the goal posts are, even Dr Lowe is unsure.
“Whether we can get there, I don’t know,” Dr Lowe said in the Q&A.
“But stronger growth in wages than we have had over the past decade is in the national interest, underpinned by productivity growth.”
What Dr Lowe is saying here is that attempting to achieve this nirvana is beneficial to Australia in its own right. There’s no harm in trying.
2022: The year for full employment?
Stripped back to their building blocks, economies are trillions of intertwined behaviours and decisions.
There are far too many factors playing into Australia’s attempt at economic nirvana to detail here, so today we’ll just focus on a few big ones.
Dr Lowe mentioned them before: Jobs, labour productivity and wages.
In other words, how much work is there, what does that work produce, and who is benefiting from that work?
These three factors underpin the conditions for economic empowerment for every Australian worker.
Let’s start with jobs – the labour market is the foundation of our economy.
The goal here is to generate enough work that bosses across Australia find it hard to secure more labour, forcing the price of it (wages) upwards.
Going back as far as World War II that condition has been called full employment.
The issue is, no one is sure what full employment actually looks like.
It appears simple, just push down unemployment until wages rise, right?
Sure, but the unemployment rate today is 4.6 per cent, the lowest it has been in more than a decade, and we still aren’t seeing many signs of higher wages growth at the economy-wide level.
Economists, including Dr Lowe, believe we’ll need to push the jobless rate to new-found lows – perhaps even below 4 per cent – to really push up wages because of structural changes like insecure and flexible work.
The good news is, 2022 might be the year Australia achieves this goal.
“We know the competition for talent is fierce right now – businesses are struggling to find suitable candidates for some roles,” APAC Indeed economist Callam Pickering said.
“All that would point towards wage pressures increasing next year.”
Both major political parties have adopted economic strategies designed to push unemployment to record lows and about $300 billion worth of government spending has been put into the economy during COVID-19.
Much of that money has flowed into household balance sheets, and the hope is that a resulting spending boom next year will lift demand and put businesses in a position to hire more workers than ever.
“We have conditions in the economy that should facilitate higher wages,” Mr Pickering said.
But it’s not that simple.
The latest Treasury forecasts predict Australia’s unemployment rate will only fall to 4.5 per cent by July and to 4.25 per cent by July 2023.
The RBA is slightly more optimistic, forecasting a 4.25 per cent rate by December 2022.
In either case, the jury is still out on whether full employment will be achieved next year, even after the post-COVID jobs rebound.
Slow and steady? Wages growth
If Australia achieves full employment, or just gets closer to it than it is today, economists like Dr Lowe expect employers across the economy will lift wages more quickly.
The goal here is a boost in pay packets high enough to push up demand for goods and services, resulting in higher inflation and stronger growth.
It’s the special sauce that helps drive higher living standards over time.
But more than a decade has passed since that equation has worked.
Annual wages growth has languished below 2 per cent for years and only just managed to reach 2.2 per cent over the September quarter this year.
The reasons for this are numerous, but many of them are deep-seated structural issues that are hard to turn around, as Dr Lowe has pointed out.
“There are certainly hotspots in which wages are increasing briskly, but most workers are still receiving wage increases with a two,” he said earlier this month.
Higher rates of insecure work, the globalisation of the labour market and more persistent competitive pressures facing businesses are just some of the factors that have kept wages growth on ice over the past decade.
The question is whether COVID measures like closed borders and higher consumer spending thanks to government stimulus will be enough to shake off this malaise, and get pay packets moving again.
The RBA expects wages growth to rise to 2.5 per cent by 2023, while the Treasury is forecasting a 2.75 per cent rate by July 2022.
If the forecasts are accurate, it won’t be enough to achieve the lofty goals Dr Lowe has set out.
Australia’s productivity problem
Although the unemployment rate is key to getting wages moving again, the underlying factor responsible for long-term wages growth and growth in living standards across Australia is productivity growth.
Labour works capital to produce income, which is then split between returns to capital investors (often dividends) and returns to workers (wages).
When labour produces more income from capital over time, that means labour productivity has risen. Ideally, this should push up wages growth.
The problem is, Australia has a massive productivity problem.
The latest ABS data shows labour productivity grew at just 1.1 per cent in 2020-21.
That’s around where productivity growth has languished for a decade.
In the post-mining boom economy, Australia has suffered from low business investment, which means bosses aren’t doing enough to improve their capital (e.g. equipment and technology) to allow workers to produce more income over time.
And on the other side, workers have also struggled to improve their skills through education and training.
That makes it more difficult to find new ways to innovate and change processes for producing more income.
“When I entered the labour market it was quite tight and firms spent a lot of resources attracting and retaining people,” Dr Lowe said on Thursday.
“That drives productivity growth … I’ve been talking quite a lot about the importance of reinvesting in training and skills. I think that’s a job for both business and government to support that.”
On the business side of this equation, there are at least positive signs.
Business investment is on the rise, growing 12.9 per cent annually in the September quarter as bosses prepare to cash in on the COVID rebound.
This should help support higher productivity growth over the medium term, if this trend continues.
But on the government side, there are few signs that either major party has any concrete policies to reform the economy and drive productivity.
Economist Saul Eslake isn’t optimistic we’re about to get any, either.
“There’s no reason to think we’re going to see an acceleration in productivity growth beyond what we were having pre-COVID,” he said.
Mr Eslake said the digitisation of businesses during COVID might be one exception to this.
“Apart from that, I struggle to see anything that would lead me to believe that productivity growth is going to be faster … I don’t see governments doing anything.”
It all points to a year of potential but much uncertainty for Australian workers.
Where to now?
There are genuinely positive signs that the rebound from COVID-19 will deliver the foundation for higher living standards over the next decade.
But things could just as easily swing back the other way, and after a big rebound, settle back into the ‘dog days’ of the past decades.
Evidently concerned that may happen, the RBA is determined to keep the official interest rate at record lows until hard data shows the malaise is lifting.
In that same Q&A, Dr Lowe reiterated that wages growth and inflation will need to be sustained within RBA target ranges for rates to rise, which is not expected to happen next year.
But 2022 will be an important step on the road to try and get there.