Australia's opponents of the minimum wage increase ignore this truth: higher pay means more people working

Michele Mossop / Getty ImagesAustralia’s agricultural sector finds it hard to get workers — but that wouldn’t be a problem if they were paying really strong wages.

The 3.5 per cent increase in the minimum wage announced by the Fair Work Commission was slammed in some quarters, with Australian Industry Group Chief Executive Innes Willox saying it would “be a major disincentive to employment”.

Not to be outdone, Russell Zimmerman, the Executive Director of the Australian Retailers Association said the wage rise would “delay staff employment and potentially lead to job losses”.

These views are commonplace amongst the bulk of economists and policy makers, but it reflects a lop-sided view of the economics of labour markets.

There is an overwhelming bias that looks at low wages as the fundamentally important way to achieve higher employment and a lower unemployment rate, with high wages growth hurting employment as Willox and Zimmerman suggest.

As the core of this view is one part of the basic economic theory of supply, demand and prices.

The view is that if wages (the price of labour) are held lower, demand for workers (from employers) would increase and as a result, the level of employment will rise and the unemployment rate will fall.

This approach to labour market economics ignores the supply side which in this instance is a workers’ willingness to supply their labour for a given wage.

If wages are too low the worker will not supply their labour. Wages being “too low” includes leaving the worker a sufficient surplus of cash after covering the cost of transport to and from work, making alternative plans in their household when the worker is at work and the give up of leisure time, among other things.

If the costs of supplying labour are greater than then benefits (the wage), there will actually be lower employment and, importantly in the context of Australia’s demographic changes, this will lead to a lower workforce participation rate than would otherwise be.

Fruit growers are a high profile example of a business where finding workers is apparently difficult. This is not because there is a shortage of labour. Unemployment and underemployment in regions near where fruit is grown is high. Many people are willing and able to work.

Basic economics tells us that the problem is the miserably low wage offered by fruit growers for the task at hand. If they paid a higher wage — and let’s for a moment be a bit silly for the sake of illustration and say that was $100 an hour — they would undoubtedly be inundated with applications to pick apples, strawberries and peaches.

Price signals work in both directions.

When we look at the recent trends in the labour market, we can see some of these supply, demand and wage trends cutting through in a non-conventional, but fully logical, way.

High wages growth, lower unemployment

In recent years, the economy has delivered record low wages growth. Since 2014, the annual increase in the wage price index has been below 2.5 per cent and the most recent data show growth of just 2.1 per cent.

The conventional labour market economics would suggest that this weakness in the cost of labour would have sparked a sharp fall in the unemployment and underemployment rates.

Alas, the data shows little change in the unemployment and underemployment rates over that time. The unemployment rate is currently hovering around 5.5 per cent. In 2013, the unemployment rate was also hovering around 5.5 per cent.

So much for low wages as a cure to unemployment.

Just as concerning, the underemployment rate has actually increased in the period of low wages growth. It stood at 8.4 per cent in February 2018, which compares with rates under 8 per cent in 2013 and 2014.

While demand for labour has been solid over recent years, as evidenced by the various measures of job vacancies, the willingness of labour (workers) to supply their labour at low wages rates is not strong.

If we look back at the most recent experience when wages growth was strong, in the period around 2004 to 2008 when the annual increase in the wage price index was around 4 per cent, the unemployment rate was anchored around 4 to 4.5 per cent and the underemployment rate was between 6 and 7 per cent.

High wages growth was linked to a more fully employed workforce.

This is not what the proponents of low wages would have us believe.

Decent wages growth are also an important part of a well-functioning economy. When wages growth is weak, like now, the only way many workers can maintain their basic expenditure is to either accumulate more debt or to lower their rate of savings. There is no other source of finance to fund spending.

Wages growth is inexorably linked to household spending which makes up over half of GDP. When wages and household spending growth is weak, the overall performance of the economy also tends to be weak.

When wages increase at a decent sustainable pace, workers will be more willing to supply their labour than when wages growth is low. History shows that strong wages growth is linked to low unemployment, not that this is what the proponents of low wages would have you believe.

Stephen Koukoulas is managing director at Market Economics, a former chief economist at Citibank, and a prime ministerial advisor on economics. He tweets at @TheKouk

NOW WATCH: Money & Markets videos

Want to read a more in-depth view on the trends influencing Australian business and the global economy? BI / Research is designed to help executives and industry leaders understand the major challenges and opportunities for industry, technology, strategy and the economy in the future. Sign up for free at research.businessinsider.com.au.