A key link between low unemployment and higher wage growth in Australia may be broken

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Despite strong recent growth in Australian employment, low wage growth may be here to stay.

In a research note on the outlook for global inflation, Capital Economics chief economist Paul Dales assessed the structural forces at play in Australia’s labour market.

Dales cited the changing shape of the Phillips Curve as part of his analysis, which has been well-documented.

The Phillips Curve plots the inverse relationship between low unemployment and higher inflation.

Historically, as unemployment decreases inflation rises which causes the curve the steepen. In recent years though, unemployment has steadily fallen across developed economies (including Australia) but inflation has remained stubbornly low.

That’s partly explained by low wage growth, given the natural relationship between higher wages and people paying more for goods and services.

Yesterday’s wage data in Australia was a case in point — annual wage growth for the June quarter was sluggish, dragged lower once again we soft growth in the private sector.

At an annual rate of 1.9%, wage growth remains below headline inflation despite the recent strength in total employment.

Monthly employment beat forecasts through the middle part of this year, and another increase today will mark 10 straight months of employment growth in Australia. July employment figures will be released by the ABS at 11:30am AEST.

Dales argues that if even employment continues to grow wages may not be quick to follow suit.

He cited the heavy prominence of the services sector in the composition of Australia’s workforce, given that it tends to employ for part-time or temporary workers.

“Those workers are poorly placed to negotiate wages compared to those in full-time, permanent employment,” Dales said.

Despite that, he noted that Australia’s workforce is already quite flexible, ranking second among a list of its peers in OECD countries:

Capital Economics

Rather, Dales said the impact of technology will have a bigger effect on compressing wages in the Australian economy because it will make businesses less cost-sensitive to changes in demand.

“So when a firm receives more orders, it doesn’t need to hire more workers to meet the extra demand,” Dales said.

Dales said that such a dynamic is even more prevalent for online merchants, as they can often boost sales with no increase in marginal costs.

This becomes more common as internet speeds rise and more products can be delivered online.

Dales said that the relatively slow internet speeds in Australia means there’s plenty of room for growth in this area as internet speeds increase:

Capital Economics

The effect of that these changes is that the Phillips Curve will stay flatter than in the past, and “that’s not going to change over the next decade”, he said.

As for the impact of lower wage growth on the inflation, Dales said inflation growth is likely to track at around 2% — consistent with its current level and at the bottom end of the RBA’s 2-3% target range.

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