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A flexible labour market – just what we need

David Bassanese
Wednesday, August 19, 2015

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By David Bassanese

The floating of the Australian dollar over two decades ago provided much needed added flexibility to the economy. When the economy is growing too strongly, the exchange rate tends to rise – dampening import price inflation and reducing demand in the trade-exposed sectors. Similarly, when the economy is weak, the $A tends to fall – boosting demand for our exports and given some reprieve for those that compete with imports.

Yet judging from recent analysis from the Reserve Bank of Australia, our economy is starting to demonstrate added flexibility in an unlikely area: the labour market. The combination of further deregulation in the market over recent years – not to mention intensifying global competition and casualisation of the workforce – is leading wages to respond more flexibly to changes in labour demand, which in turn has lessened the upward pressure on the unemployment rate.

In a speech last week in Brisbane, RBA Assistant Governor Christopher Kent noted the “behaviour of wages during the current episode has been comparable to the experience around the 1990s recession.” As seen in the chart below, annual growth in average earnings has declined by around 5 percentage points since the trough in unemployment in 2011 – about the same decline as during the early 1990s recession. Of course, the big difference between now and then was that the unemployment rate rose much more aggressively in the early 1990s. As such, it’s prima-facie evidence for the view that wages growth has become more flexible.

One reason for this flexibility is the fact that those in the mining sector – which have endured boom-bust conditions in recent years – are more likely to be hired through relatively less regulated individual work contracts. Wages growth in the sector boomed during the mining sector upturn, and so the downside to wages during the subsequent downturn is also showing more flexibility.

Were this the only source of flexibility, however, it would seem a more one-off cyclical phenomena – given that huge mining cycles of the type seen recently are more the exception than the rule.

That said, new flexibility also appears to have emerged on the supply side. Growth in the use of temporary skilled-work visas (so-called ‘457s’) mean increases in local labour demand can now be more easily met by “importing” required labour from overseas – with these workers then heading home when demand cools. The rising share of part-time employment, particularly by females with dependent children, also adds to labour supply flexibility. All up, this means that labour supply is more cyclically sensitive, which in turn suggests the unemployment rate should tend to show less volatility over the cycle.

Labour mobility between Australia and New Zealand has long been a feature of our respective labour markets, but recent economic shocks have added to the flows across the Tasman. As Kent noted, the downturn in Australian mining activity coincided with the increased demand for construction workers in New Zealand to help rebuild Christchurch after its devastating earthquake. The net result is that the usual net flow of workers from New Zealand to Australia has slowed notably, reducing upward pressure on the unemployment rate that might have otherwise occurred due to the mining downturn.

Last but not least is compositional change. The re-balancing of the economy from mining to the non-mining sectors is also a re-balancing of growth towards largely labour-intensive service and home construction sectors.

As a result, overall labour demand has tended to improve, even though overall economic growth has not changed much and remains sub-par.

Kent also concedes that either employment growth and/or GDP growth could also still be subject to significant revision – but the idea of increased labour market flexibility and compositional change toward labour-intensive sectors makes intuitive sense.

The downside from such an analysis is that the failure of the unemployment rate to rise in recent months is not necessarily because overall economic growth is much stronger than currently estimated.

What’s happened is that labour productivity growth has slowed, and workers have effectively been more willing to cut their wage demand in order to keep their jobs. Of course, it’s better than having the unemployment rate rise to 6.5% or beyond – but it does mean growth in household incomes and corporate profits could well remain quite subdued.

Published: Wednesday, August 19, 2015

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