If wages don't rise, Scott Morrison's budget surplus could be in danger

2016 Liberal Party election materialReal tradies will need real wage increases.
  • The Australian government sees wage growth lifting to 3.25% in the 2019/20 fiscal year, an increase that will help to boost nominal GDP growth and tax revenues.
  • Many economists believe these forecasts are too optimistic, creating downside risks to tax revenues in the years ahead.
  • Australia’s unemployment rate sits at 5.5%, above the 5% level or below where wage growth is expected to accelerate.

The Australian government is betting big on an acceleration in wage growth to bring the budget back to surplus.

Based on Treasury’s latest forecasts, it sees Australia’s wage price index (WPI) — currently sitting at 2.08% — lifting to 3.25% in the 2019/20 fiscal year, a meaningful increase that will help to boost nominal GDP growth and, as a consequence, tax revenues.

However, economists aren’t convinced, suggesting the overly-optimistic forecasts create downside risks for budget revenues in the years ahead.

“The main downside risk in the government’s assumptions is the expectation that the ongoing strong labour market generates a substantial lift in wages growth from the current 1.9% to closer to 3.25% by mid-2020,” says Annette Beacher, Chief Asia-Pacific Macro Strategist at TD Securities.

“If revenues fail to live up to these projections then fiscal deficits will continue for longer as spending promises tend to be difficult to revoke.”

Cherelle Murphy and Jack Chambers, economists at ANZ Bank, conveyed a similar view on the downside risks to revenues.

“The biggest divergence between the Government’s forecasts and ANZ Research’s is that the Government is expecting the Wage Price Index to grow 3.3% in 2019-20, unchanged from MYEFO, compared to ANZ’s forecast of 2.6%,” they said.

“If Government’s wage forecast proved to be too optimistic it would imply that its revenue forecasts from income taxes were also too high.”

Ratings agency Moody’s also warned that “uncertainty persists on whether wages growth will pick up significantly enough to support revenues.”

As Michael Blythe, Chief Economist at the Commonwealth Bank points out, wages are the key to many parts of the economic and policy story at the moment.

“A sustainable improvement in the Budget bottom line is difficult to achieve without the revenue flow from higher wages,” he says.

“It is difficult to see a turn in the inflation and interest rate story without a lift in wages growth. And a wages boost would alleviate some of the strains on household budgets and reduce the risks from high levels of household debt.

“Small wonder that RBA Governor Lowe has returned repeatedly to the need for wages to lift.”

While most, including the Reserve Bank of Australia (RBA) believe that wage growth has now bottomed, no one can be really sure as to how quickly wage growth will accelerate in the years ahead.

Indeed, Treasury doesn’t have Australia’s labour market reaching full employment — widely regarded as being around 5% — until fiscal year 2021/22, more than four years away.

Despite this, it expects wage growth will still pick substantially over this period, at least compared to levels seen in recent years.

Creating additional uncertainty, there’s no guarantee wage growth will accelerate meaningfully even if unemployment falls to 5%.

One only has to look at other advanced economies such as the United States, United Kingdom and Japan — where labour market conditions are far tighter than Australia — for evidence that low unemployment does not necessarily translate to faster wage growth in the post-GFC era.

The RBA is acutely aware of this phenomenon, noting last week that there is “uncertainty around the level of the unemployment rate that is consistent with full employment”.

“If experience overseas is any guide, this level of the unemployment rate could turn out to be lower than previously assumed,” it said.

Some economists estimate that the non-accelerating inflation rate of unemployment in Australia (NAIRU) — the level where wage growth will begin to accelerate — could be as low as 4%.

Despite what’s been seen abroad, and increased uncertainty about the trajectory for wage pressures, that’s not been enough to dent the government’s optimism over what lies ahead for worker wages.

Time will tell if Australia will be able to buck the global trend.

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