RBA Governor Philip Lowe believes one really big factor is holding back Australia's economy

Andrew Redington /Allsport
  • Some believe the pathway to stronger prosperity levels is higher population, greater labour market participation and productivity growth.
  • Of the three, productivity growth remains the one weak spot in Australia.
  • This is contributing to weak wage growth outcomes at present, creating challenges for policymakers and borrowers alike.

When it comes to maintaining and building prosperity levels, many believe the solution can be found using just three words.

Population, participation and productivity, known as the three “Ps” for short.

In Australia right now, we’re currently two-thirds of the way there.

Our estimated resident population, as measured by the ABS, is currently growing at 1.6% per annum. Labour force participation is also lifting strongly, indicating that a greater proportion of Australia’s working-age population is either in employment or actively looking for work.

RBA

However, of all the three Ps, productivity growth — what Australia produces — is continuing to hold the economy back.

Despite a record number of Australians being in work and strong population growth, it’s not increasing all that fast, keeping Australian economic growth sluggish, making it harder to lower unemployment and boost wage and inflationary pressures.

That’s something Reserve Bank of Australia (RBA) Governor Philip Lowe touched upon in a speech to the Australian Industry Group in Melbourne today, noting that despite strong employment growth over the past two years, productivity growth has been weak.

“Over the past couple of years, output growth has been subdued, but employment growth has been strong,” Lowe said in his speech.

The question is why?

In order to evaluate recent trends, Lowe suggests that it is useful to examine what has been happening in the broad industry groups across Australia: goods-related industries, business services and household services.

In recent years, and despite strong levels of employment growth, Lowe says its clear that productivity in household services, where around 40% of all Australians work, has been especially weak in the years following the global financial crisis.

“Employment growth has been especially strong in household services over recent times, yet measured productivity growth in this area of the economy has been quite weak,” he says.

“Output per hour worked in this set of industries is only 4% higher than it was in 2010.

“In contrast, over this period, output per hour worked is up 13% to 16% in the other industry groups.

“This is quite a different picture.”

RBA

While the divergent productivity performance could be explained by difficulty of measuring output in some service industries, Lowe suggested that productivity growth in the services sector is weighing on the outcome for the economy as a whole, pointing for the need to invest more in human capital to help buck the recent trend.

“One of these steps is ensuring a strong ongoing focus on training, education and the accumulation of human capital,” he said.

“Our national comparative advantage will increasingly be built on the quality of our ideas and our human capital.”

He also nominated other factors such as the design of Australia’s tax system, the provision and pricing of infrastructure, the way we finance innovation and new businesses and our business culture around innovation, risk and entrepreneurship as areas that business leaders and policymakers need to focus on to help lift prosperity levels further.

And that includes delivering higher real wage outcomes for workers.

“The best outcome is one in which a pick-up in wages growth is accompanied by stronger growth in labour productivity,” Lowe said.

“That’s because, ultimately, the basis for sustained growth in real wages is that we become more productive as a nation.”

Given current trends, that appears unlikely to arrive anytime soon.

Regardless of which wage measure you use, most in Australia are sitting at or just above 2%, well below the levels seen as little as a decade ago.

RBA

Lowe suggests there are both cyclical and structural explanations for why wage growth has slowed so much in recent years.

On the cyclical side, he said there is still spare ample capacity in Australia’s labour market, as seen in the level of unemployment and underutilisation which remain at elevated levels as strong growth in participation offset similar strength in hiring.

From a structural perspective, he said factors relating to competition and technology have also contributed to recent low wage growth outcomes.

While he remains optimistic that this won’t remain the case forever, Lowe again cautioned that the pickup in wages is expected to be only gradual given the cyclical and structural factor at work.

In the interim, Lowe said it is clear that the slow growth in wages is creating negative headwinds for the economy,

“One is that the low growth in wages is contributing to low rates of inflation in Australia,” he said.

“Indeed, if wages growth were to continue at around its current rate for an extended period, it is unlikely that the rate of inflation would average around the midpoint of the inflation target in the period ahead.”

He added that “wages growth of 2% and reasonable labour productivity growth are unlikely to make for 2.5% inflation on a sustained basis”.

Put bluntly, should the status quo remain in place, the RBA is unlikely to be in a position where it can lift interest rates in the future.

It’s also worthwhile noting that, in most instances, tighter monetary policy settings are only seen when economic conditions are improving.

As Lowe himself pointed out, an environment in which interest rates are increasing is also likely to be one in which people’s incomes are growing more quickly than now.

Along with making it more difficult to deliver on its policy mandates, Lowe said that another consequence of weak wages growth is that real debt burdens stay higher for longer.

“Many people who borrowed expected their incomes to grow at something like the old rate rather than the current rate,” he said.

“With their expectations not being realised, the real value of the debt stays higher than they expected and this is likely to affect their spending decisions.”

Lowe acknowledged that it also risks diminishing our sense of shared prosperity, something he admits makes much-needed economic reforms more difficult to deliver.

“Given these various effects, some pick-up in wages growth would be a welcome development. It would help deliver a rate of inflation consistent with the target, it would help with the debt situation and it would add to our sense of shared prosperity,” he said.

“In my judgement, a return, over time, to a world where wage increases started with a 3 rather than a 2 is both possible and desirable.”

While possible, Lowe doesn’t appear optimistic that will arrive in the near-to-medium term, especially given the evidence from other major developed economies where the relationship between tightening labour market conditions and faster wage increases isn’t anywhere near as strong as it was in prior decades.

As such, he again repeated that while the next move in the RBA cash rate is still likely to be higher, it still looks to be some time away.

“The Board will want to have reasonable confidence that inflation is picking up to be consistent with the medium-term target and that slack in the labour market is lessening,” he said.

“At this stage, a sustained pick-up in inflation to around the midpoint of the target range is likely to require faster wages growth than we are currently experiencing.

“There are reasonable grounds to expect that this increase in wages growth will occur. But for the reasons I have spoken about today, this increase is likely to be only gradual. Given this, there is not a strong case for a near-term adjustment in monetary policy.”

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