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Opinion - Only more productive workers get bigger pay packets

Last week rallies around Australia saw workers and unions taking to the street demanding better working conditions, including greater job security, and higher wages. The ACTU’s Sally McManus claims that “the industrial relations system has completely broken down and this is leading to a world of insecure work and low wage growth” and “the nation needs a pay rise, and we need to change the rules so we have balance in our system and workers can get their fair share”.

Nominal wage growth in Australia has averaged only 1.8 per cent per annum since 2013, which is less than half the average annual growth rate of nominal wages recorded over the previous 18 years. This has confounded economists and politicians alike, and caused employees’ resentment.

In KPMG’s new study, Wages, productivity and technology, we sought to examine this wages growth puzzle using industry data, including contrasting the outcomes in the past five years with those of a longer period extending back to 1995.

First and foremost, the findings of the study show there has not been a breakdown in the fundamental economic relationship that drives wages growth in Australia, either over the last few years or over the longer term.

Three key factors

KPMG’s analysis shows that wages growth in Australia continues to be driven by three key factors; labour productivity, the mix of capital and labour that an industry employs, and the amount of high-tech capital utilised by each industry. Importantly, high-tech capital relates to more than just computers; but also intellectual property, research and development, software and electronic equipment.

Our modelling shows that across all industries, slightly more than half of the change in real producer wages – wages from the perspective of the employer – comes from changes in labour productivity, while nearly 40 per cent is due to an industry’s propensity to employ more high-tech capital and engage in capital-deepening.

Arguments that labour productivity in Australia has recently been non-existent, or materially below our long-run average, are not true when we look at the performance of individual industries. There has been significant variation across sectors over the past two decades, and some evidence that since 2013 a given increase in labour productivity has translated into a smaller increase in real wages than was previously the case.

While our analysis confirms the wages system in Australia is not broken, it does show something is now different in how productivity, capital stock mix and technology either individually or collectively interact to determine wages growth. The step-change in the importance of high-tech capital as a driver in wages growth means industries that are proportionally increasing their use of such capital are more likely to be able to reward workers with real wages growth than industries that do not.

Terms of trade

Carrying out research and development and creating intellectual property have been spruiked as key in making Australia an innovative nation. Our analysis shows that these activities are not just important to diversifying and strengthening our economy, but in driving real wage growth.

Another piece of the puzzle we were able to show was that for small open economies, like Australia, the terms of trade can have a significant role in influencing real wages.

Our lived experience has been precisely that; upswings in our terms of trade, notably during the commodities boom, helped workers achieve real wage increases that improved their purchasing power, and once the benefit of the terms of trade improvements dissipated, real wages in Australia from the perspective of the consumer have remained virtually flat.

This is most notable in the mining industry, which has seen dramatic rises and falls in real producer wages over the past two decades, given the high volatility in the market price for mining outputs. A price rise in those outputs has the effect of lowering the cost of labour to the employer, which explains why employment growth has been strong and in periods of low inflation employees working in the mining industry experienced relatively high real wages growth.

KPMG’s report confirms another key outcome. When the factors driving real wages growth in Australia do not rise, but for whatever reason real wages grow by more than the increases in prices received by businesses, then employment falls. Simply, when employers experience an increase in the prices of the goods and services they sell, they have a choice – either to give existing workers higher real wages or employ more workers, but they cannot do both unless Australia gets an external boost in our terms of trade.

Stark reality

Adopting a policy framework that forces real wages to rise more than changes in labour productivity and capital-mix, including high-tech capital usage, suggest is appropriate, will simply result in employment in Australia being lower than it otherwise should be. That is a stark reality facing policymakers.

If the government – of whichever colour after the election – is looking to ensure Australians enjoy real wages growth then it should be pursuing policy settings that promote productivity growth, capital-deepening and proportionally more investment in high-tech capital.

 

This article was published on the Australian Financial Review website. Click here to access the original article (subscription required).