This equation may explain why Australian jobs growth remains strong despite the slowdown in the economy

IMDbGood Will Hunting. Be Gentlemen Limited Partnership. Lawrence Bender Productions. Miramax.
  • Australia’s economy slowed sharply in the second half of last year. However, hiring remained strong over the same period.
  • Many believe that’s because employment is a lagging economic indicator, reflecting the relative strength in the economy in the past. If correct, hiring should slow quite sharply this year.
  • The Commonwealth Bank says another factor could explain why employment growth has been resilient. Growth in labour costs has been weak.
  • The scenario of weak economic growth and strong hiring has been described as an area of “tension” by the RBA. When this tension is resolved it will likely determine if and when the RBA will cut official interest rates.

Australia’s economy slowed sharply in the second half of last year yet hiring, from a broad perspective, did not.

It’s still running at a relatively brisk pace of over 270,000 per annum, or just over 2%.

Many believe that merely reflects that employment is a lagging economic indicator, reflecting strength in the economy in the past rather than today. If that’s correct, the sharp deceleration in the economy last year should see employment growth begin to slow in the months ahead. Most leading indicators suggest that’s likely to take place.

However, not everyone agrees.

According to the Commonwealth Bank, the relative strength in hiring, despite the slowdown in the economy, can be explained by the fairly complex equation below.

Commonwealth Bank

According to the bank, it’s a model that uses current and lagged values of quarterly GDP growth and quarterly growth in real labour costs to estimate quarterly growth in employment.

Real labour costs measure wages and salaries, paid leave, superannuation, taxes on employment, training and recruitment costs, and fringe benefits, according to the ABS, and are adjusted for inflation.

Now we know what most of you are thinking: what the heck is that and what does it say about why hiring has, to this point, managed to defy growing expectations for a slowdown.

For the not so mathematically gifted, Kristina Clifton, Senior Economist at the Commonwealth Bank, has provided a useful summary of what has helped to keep hiring strong in the face of far slower economic growth: weak labour costs.

“Using regression analysis we find that employment growth responds to both current and past economic growth,” she said. But the relationship between the two has lessened significantly in recent years.

“Adding real labour costs into our model improves the fit. Falling real labour costs in recent years has helped to support employment.”

This chart from the Commonwealth Bank shows how actual employment growth has compared to its model that includes both GDP growth and changes in labour costs, referred to as ‘model 2’. ‘Model 1’ just includes GDP growth, not labour costs.

Commonwealth Bank

“A fall in real labour costs over the past year helps explain strong employment growth but weak GDP growth over the second half of 2018,” Clifton said.

While the model has done a reasonable job in tracking employment growth in the past, Clifton said it is not as useful for predicting employment growth in the future given GDP growth and labour costs would have to be estimated in the modelling.

Whether or not the slowdown in the economy will see employment growth fall sharply in the coming year is an area of debate at present, especially in economic circles.

Some think jobs growth will slow significantly, potentially placing upward pressure on unemployment and increasing the risk of rate cuts from the RBA. Others, however, disagree, including the Commonwealth Bank who still see the next move in Australia’s cash rate being higher, albeit not for several years.

The divergence between slower economic growth and firm hiring has been described as an area of “tension” by the RBA.

In recent commentary, the bank has acknowledged that it is awaiting new information that could help resolve those tensions.

On Thursday, the ABS will release job vacancy data for the three months to February. The RBA has frequently pointed to continued growth in vacancies in this series as a major factor underpinning its view that unemployment will continue to drift lower in the years ahead.

Given the level of uncertainty about the strength of hiring in the months ahead, this report could go someway to determining whether or not the tensions seen by the RBA are resolved.

Business Insider Emails & Alerts

Site highlights each day to your inbox.

Follow Business Insider Australia on Facebook, Twitter, LinkedIn, and Instagram.