Can we afford real wage cuts and soaring rate hikes as households struggle to balance budgets?

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You’d think we’d get better at predicting the future.

Consider all those high-brow economic models, the amount of brainpower employed — not to mention the huge store of data and experience — we can draw upon.

But our success rates in anticipating problems seem to be on the decline. When it comes to solving them, the situation is even worse.

Perhaps the reason isn’t quite so mysterious. Just like religion, the theories around economics can be interpreted in whatever way best suits you. And, in an era when rational debate and a desire for consensus have been displaced by a polarising dash for the extremes, economics has become a turbulent battleground.

Take the debate over wages right now.

If you believe most business and bank economists, we’re on the edge of an abyss. Just like in the 1970s, they argue, we are in the early phase of a debilitating cycle of spiking wages and prices that threatens our future and without firm action to stamp it out pronto, we’ll be doomed.

It’s an argument thoroughly embraced by the Reserve Bank of Australia, along with every other central bank. In a rare display of unity, all of them are in a panic, pushing through interest rate hikes at lightning speed to plunge a knife into the heart of what they fear most, inflation.

There’s just one minor detail they appear to have overlooked. Things have changed since the 1970s, a lot.

Wages aren’t soaring. And they’re unlikely to. They might be rising at the fastest clip in seven years. But they have come off the back of the slowest growth in history and, in real terms, they are plunging.

Extreme shortages, modest price rises

A two storey home with scaffolding and a white tarp on the roof. Behind is a bungalow with an orange tarp.
A shortage of building materials has seen house renovation prices surge and slowed construction.(ABC Midwest and Wheatbelt: Samille Mitchell)

Adam Smith would be turning in his grave. The Scottish lawyer and philosopher, who penned the first modern work on economics in 1776, is still regaled as the standard bearer for free market thinking.

And yet, here we are, 250 years later, unable to come up with a logical explanation for a couple of very simple questions.

Why has wages’ growth been so slow? And, given we now have the lowest unemployment rate in half a century with more available jobs than workers to fill them, why are wages still only growing modestly?

On the surface, it’s a phenomenon that defies all economic theory. Hey, we know why we’re paying through the nose for fuel. There are global shortages following Russia’s invasion of Ukraine.

The same goes for building materials. Prices for some have jumped more than 30 per cent because shipping delays and lockdowns in China have created massive shortages. The price of second-hand cars is soaring because there is a shortage of new ones.

It’s a trend running right through the economy.

A photo shows three workers at their computers, sitting along a shared desk
Only 14 per cent of private sector workers received a pay rise in the June quarter.(Unsplash: Arlington Research)

But when it comes to the cost of labour — paying a human being to perform a service — the normal rules of economics don’t seem to apply.

Wages, on an annual basis, are rising at just 2.6 per cent. That’s way below inflation at 6.1 per cent. And it comes at a time when we supposedly have — yep, you guessed it — a chronic shortage of labour.

A little dig into last week’s wages data reveals some fascinating tidbits. Those private sector workers, who did get a pay rise in the June quarter scored — on average — a 3.8 per cent pay jump which sounds quite tidy.

But only 14 per cent of private sector workers received a raise. And many of them were given a one-off bonus, rather than a permanent pay rise.

Just for a bit of perspective, it should be remembered that for most of the Howard government, wages were growing at a much higher pace, between 3 and 4 per cent per annum.

So, what gives?

A black and white photograph outside the George Hotel near the corner of Grey and Fitzroy streets in St Kilda.
Australia in the 1970s was often shackled by industrial action and rampant inflation.

  (State Library of Victoria Archive: Maggie Diaz)

Perhaps the biggest problem is that labour doesn’t operate in a free market, so prices — wages — don’t respond as readily to supply and demand changes.

That’s particularly the case now because — when it comes to the power balance, the pendulum during the past half-century has swung away from workers and towards business.

For much of the 1970s, Australia was gripped by industrial chaos. Inflation ran rampant through the developed world and our strongly organised labour force demanded, and in many cases received, compensation. That further entrenched inflation and fuelled a vicious cycle of price rises.

Not any more. The changes began with the Hawke-era Accords, where workers agreed to moderate wage claims and to back off from industrial action in exchange for a superannuation scheme.

It continued on through the Howard government era with WorkChoices and the Rudd/Gillard years with the introduction of Fair Work Australia. You now need court approval to go on strike.

Imagine telling that to a trade union boss in the 1970s.

A graph showing industrial disputes in Australia

Source: Australian Bureau of Statistics

The results have been astounding. In fact, the changes have been far more dramatic than even the graph above portrays. In the 1970s, the average number of days lost was more than double that of the 1980s.

No matter how you measure it, industrial action has fallen to the point where it now is a rarity.

There are other factors too. Collective bargaining, designed to even up the power imbalance between workers and firms, has waned over the years. Then there are enterprise bargaining agreements that lock in wages for years on end.

Add in the restraint in lifting minimum wages and a system that has allowed rampant wage theft, and you start to draw a picture as to why real wages have been dragging the chain.

The productivity problem

How do you fix this? Ask just about any big name economist about what should be done and you’ll get a complicated dissertation on productivity.

What they’ll tell you, is that wages can only rise if we get a lift in productivity. Essentially, if everyone works harder and produces more, then wages can rise to compensate for the extra effort because businesses would have been making bigger profits and could afford to pass on some of the proceeds.

That’s great in theory.

The only problem is that productivity has been rising strongly, for years. It’s just that workers have missed out on many of the gains as soaring profits picked up the share of income.

A graph showing Australian productivity compared to real wages over last 20 years

Source: Saul Eslake

Productivity gains, while they are always welcomed, clearly aren’t the remedy. At least, not in isolation.

Your workers are also your customers

You don’t need to be a genius to figure out that, as a boss, if you keep a lid on wages, your profits will rise.

If it’s your firm, you end up with the proceeds. If you’re running a major public company, you’ll be handsomely rewarded by the shareholders.

But too much of a good thing can be bad for you and for everyone around you. Sluggish wage growth — particularly when it is well below inflation — delivers less cash into workers’ pockets which means they spend less. Ultimately, that flows through into lower profits and a weaker economy.



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