Productivity debate descends into damned lies and statistics mode

Last week we got a big hint that the economics profession is in the early stages of its own little civil war, as some decide their conventional wisdom about how the economy works no longer fits the facts, while others fly to the defence of orthodoxy. Warning: if so, they could be at it for a decade before it’s resolved.

Economists want outsiders to believe they’re involved in an objective, scientific search for the truth and are, in fact, very close to possessing it. In reality, they’ve long been divided by ideology – views about how the world works, and should work – which is usually aligned with partisan interests: capital versus labour.

You see this more clearly in America, where big-name “saltwater” (coastal) academic economists only ever work for Democrat administrations, while “freshwater” (inland) academics only work for the Republicans.

In the 1970s, the world’s economists argued over the causes and cures for “stagflation” – high inflation and high unemployment at the same time. Then, in the 1980s, we had a smaller, Australian debate over how worried we should be about huge current account deficits and mounting foreign debt, won convincingly by the academics, who told the econocrats to forget it – which they did.

Now, the debate is over the causes of the latest global surge in inflation. At a time when organised labour has lost its bargaining power, while growing industry “concentration” (more industries dominated by an ever-smaller number of big companies) has reduced the pressure from competition and increased the pricing power of big firms, is a lot of the recent rise in prices explained by businesses using the chance to increase their profit margins?

A related question is whether it remains true that – as business leaders, politicians and econocrats assure us almost every day – all improvement in the productivity of labour (output per hour worked) is automatically reflected in higher real wages.

And that’s the clue we got last week. The Productivity Commission issued a study, Productivity growth and wages – a forensic look, that concluded that “over the long term, for most workers, productivity growth and real wages have grown together in Australia”.

So, all the worrying that silly people (such as me) have been doing – that the workers are no longer getting their cut of what little productivity improvement we’ve seen in recent years – has been proved to be a “myth”.

For the national masthead that prides itself on being read by the nation’s chief executives, this was a page one screamer. Apparently, even though real wages are 4 per cent lower than they were 11 years ago, workers are getting “their fair share of pie”.

When workers’ real wages rise by less than the improvement in labour productivity, the study calls this “wage decoupling”. It says “it is important to get the facts right on wage decoupling. Unfortunately, debates about the extent of wage decoupling, its sources and its implications are often dogged by differences in the methods and data”.

“This is because analysts can pick and choose among a wide range of measures of real wage growth, and their choices can lead to different, sometimes misleading conclusions.”

This is very, very true. Trouble is, sauce for the goose is sauce for the gander. The clear inference is that “the commission’s preferred measure” is the single correct way of measuring it, whereas all those who get different results to us are just picking the methodology that gives them the results they were hoping for.

Get it? I speak the objective truth; you are just fudging up figures to defend your preconceived beliefs about how the world works. Yeah, sure.

I hate to disillusion you, gentle reader, but this is what always happens in economics whenever some group says, “I think we’re getting it wrong.” They produce calculations to support their case, but some don’t like the idea, so they produce different calculations intended to refute it.

Because economics is factionalised, most debates degenerate into arguments about why my methodology is better than yours. That’s why a change in the profession’s conventional wisdom can take up to a decade to resolve. But intellectual fashions do change.

The study finds that the mining and agriculture industries – which account for only 5 per cent of workers – have experienced major wage decoupling over the past 27 years, but for the remaining 95 per cent of workers, in 17 other industries, the difference between productivity growth and real wage growth has been “relatively low”.

Sorry, but that’s my first objection. It’s not relevant to compare productivity growth by industry with real wage growth by industry. Some industries have high productivity, some have low productivity and, in much of the public sector, productivity can’t be measured.

Despite the things it suits the employer groups to claim, the reward held out to workers for at least the past 50 years has never been that their real wages should rise in line with their own industry’s productivity.

For reasons that ought to be obvious to anyone who understands how markets work, it’s never been promised that, say, carpenters who work in mining or farming should have rates of pay hugely higher than those who work in the building industry, while the real wages of carpenters working in general government should never have changed over the decades because their (measured) productivity has never changed.

It’s an absurd notion that could work only if we could enforce a rule that no one could ever change jobs in search of a pay rise.

No, as someone somewhere in the Productivity Commission should know, the promise held out to the nation’s employees has always been that economy-wide average real wages should and will rise in line with the trend economy-wide average improvement in the productivity of labour.

When you exclude the two industries that contribute most to the nation’s productivity improvement, it’s hardly surprising that what’s left is so small you can claim it wasn’t much bigger than the growth in most workers’ real wages.

Then you tell the punters that, over 27 years, they are less than 1 percentage point behind – a mere $3000 – where they were assured they would be.

The report finds – but plays down – that the national average real wage fell behind the national average rate of productivity improvement by an average of 0.6 percentage points a year – for 27 years.

That’s if you measure wages from the boss’s point of view (which is economic orthodoxy) rather than the wage-earner’s point of view. But I can’t remember hearing that fine print explained in the thousands of times I’ve heard heavies telling people that productivity improvement automatically flows through to real wages.

View wages from the consumer’s perspective, however, and the national average shortfall increases to 0.8 percentage points a year. And nor did anyone ever tell the punters that it may take up to 27 years for their money to arrive.

You guys have got to be kidding.

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Don't let an economist run your business, or bosses run the economy

A lot of people think the chief executives of big companies – say, one of the four big banks - would be highly qualified to tell them how high interest rates should go and what higher rates will do to the economy over the next year or two.

Don’t believe it. What a big boss could tell you with authority is how to run a big company – their own, in particular. Except they wouldn’t be sharing their trade secrets.

No, in my experience, when bosses step away from their day job to give Treasurer Jim Chalmers free advice, their primary objective is to tell him how to run the economy in ways that better suit the interests of their business (and so help increase their annual bonus).

But when it comes to keeping our banks highly profitable, our treasurers and central bankers are doing an excellent job already.

Of course, it’s just as true the other way around: don’t ask an economist to tell you how to run a business. It’s not something they know much about.

Running big businesses and running economies may seem closely related, but it’s not. They’re very different skills.

One of the ways the rich economies have got rich over the past 200 years is by what the father of economics, Adam Smith, called “the division of labour” – dividing all the work into ever-more specialised occupations. By now, managing businesses and managing economies are a world apart.

But as Free Exchange, the economics column in my favourite magazine, The Economist, explains in its latest issue, there’s more to it than that.

Conventional economic theory sees the economy as composed of a large collection of markets. Producers use resources – labour, physical capital, and land and raw materials – to produce goods and services, which they sell to consumers in markets.

Producers supply goods and services; consumers demand goods and services. How do producers know what to supply and consumers what to demand? They’re guided by the ever-changing prices being demanded and paid in the market.

So economists see economics as being all about markets using the “price mechanism” to ensure the available resources are “allocated” to the particular combination of goods and services that yields consumers the most satisfaction of their needs and wants.

It wasn’t until 1937 that a British-American economist, Ronald Coase, pointed to the glaring omission in this happy description of how economies work: much of the allocation of resources happens not in markets but inside firms, many of them huge firms, with multiple divisions and thousands of employees.

Inside these firms, the decisions are made by employees, and what they do is determined not by price signals, but by what the hierarchy of bosses tells them to do. A key decision when something new is wanted is whether to buy it in from the market, or make it yourself.

The Economist says another gap between economic theory and the world of business is the economists’ assumption that firms are profit-maximising. Well, they would be if they could be.

Trouble is, contrary to standard theory, they simply don’t have the information to know how much they could get away with. Gathering a lot more information would be expensive and, even then, they couldn’t get all they need.

As the American Herbert Simon – not really an economist, which didn’t stop him winning a Nobel Prize – realised, businesses live in a world of “bounded rationality” – they make the best decision they can with the information available, seeking profits that are satisfactory rather than ideal. They are “satisficers” rather than maximisers.

It took decades before other economists took up Coase’s challenge to think more about how companies actually go about turning economic resources into goods and services.

The Economist says a key idea is that the firm is “a co-ordinator of team production, where each team member’s contribution cannot be separated from the others.

“Team output requires a hierarchy to delegate tasks, monitor effort and to reward people accordingly.”

But this requires a different arrangement. In market transactions, you buy what you need and that’s pretty much the end of it. But, because a business can’t think of all the things that could possibly go wrong, a firm’s contracts with its employees are unavoidably “incomplete”.

Without these legal protections, what keeps the business going is trust between employer and employee, and the risk to both sides if things fall apart.

Another problem that arises within companies is ensuring employees act in the best interests of the firm, and are team players, rather than acting in their own interests. Economists call this the principal-agent problem.

In law, and in economic theory, businesses are owned by their shareholders, with everyone employed in the business - from the chief executive down – acting merely as agents for the owners. Who, of course, aren’t present to ensure everyone acts in the owners’ interests, not their own.

Economists came up with the idea of ensuring the executives’ interests aligned with the owners’ interests by paying them with bonuses and share options.

Trouble is, these crude monetary incentives too often encouraged executives to find ways to game the system. Ramp the company’s shares just before you sell your options and let the future look after itself.

Elsewhere, linking teachers pay to exam results encourages too many of them to “teach to the test”.

More recently, economists have decided it’s better to pay a fixed salary and avoid tying rewards to any particular task – which could be achieved by neglecting other tasks.

But whatever economists learn about how to manage businesses, it’s hard to see them supplanting management experts any time soon.

As The Economist observes, when a business hires a chief economist, it’s usually for their understanding of the macroeconomy or the ways of the central bank, not for advice on corporate strategy.

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Why I'm happy to bang the drum for higher wages

I’ve long believed that no government – state or federal, Liberal or Labor – should be in office for more than a decade before being put out to pasture. But I can’t say the demise of the 12-year-old Perrottet government in NSW filled me with joy.

Liberal-led governments have been falling like ninepins. But this one happened to be the only one genuinely committed to limiting climate change, improving early childhood education and care, and getting more women into politics (even if its party members weren’t playing ball).

The best thing about Dom Perrottet’s departure is the end of his cap on the size of public sector pay rises. Its removal will add to pressure for higher public sector wages in the other states – particularly Victoria – and at federal level.

It will even put a bit of upward pressure on wage rates in the private sector.

If you wonder why pay rises have been so small over the past decade, government wage caps – in Labor states as well as Liberal – are part of the reason. They’ve reduced the price competition for workers throughout the economy.

But don’t take my word for it. When he was desperate to get inflation up to his 2 to 3 per cent target range, Reserve Bank governor Dr Philip Lowe said the same.

In NSW, public sector wage rises were capped at 2.5 per cent in 2011. Only when the inflation rate started heading to 8 per cent was it lifted to 3 per cent.

There’s never a shortage of people predicting that higher wage rates will lead to death and destruction. Many Canberra lobbyists make a good living crying poor on behalf of the nation’s employers.

I’m sure there must be some businesses somewhere doing it tough, but you don’t see much evidence of it in the business pages of this august organ. The reverse, in fact.

But won’t higher wages just lead to higher prices? Yes, but not to the extent it suits business groups to claim. Wages and other labour costs don’t account for anything like the majority of the costs most businesses face.

If all firms do is pass on their higher labour costs, all it will do is slow our return to low inflation. It’s when firms use the cover of the highly publicised rises in their costs to add a bit extra to their price rises that inflation takes off.

But that’s less likely now the Reserve Bank is jacking up interest rates to slow the economy down. It won’t say so, but it’s hitting the brakes precisely because businesses were getting a bit too willing with their price rises.

Certainly, it’s not because wage rises have been too high. Few if any workers have been getting – or are likely to get – wage rises anything like as high as the rise in prices.

That’s likely to be true even for the “frontline” nurses and teachers in NSW, whose unions will be celebrating the end of the wage cap by hitting Premier Chris Minns for big increases.

It will be least true for the bottom quarter of workers dependent on the national minimum wage and the range of minimum wage rates set out in awards, who are likely to be awarded decent pay rises by the Fair Work Commission, as they were last year.

We can’t possibly afford that? Really? Nah. “If you made a list of all the things that are giving us this inflation challenge in our economy, low-paid workers getting paid too much wouldn’t be on that list,” Treasurer Jim Chalmers has said.

Why am I happy to bang the drum for higher wages? Because, as any year 11 economics student could tell you, the economy is circular.

Business people may begrudge every cent they pay their workers, but they’re pretty pleased to have all those dollars back when the nation’s households front up at their counters.

A big part of managing a capitalist economy involves saving short-sighted business people from their folly.

As for minuscule public sector pay caps, ask yourself why it’s fair enough to expect people who work for the government to accept lower rates of pay. Because they’re second-class citizens? Because they stand around leaning on shovels?

Because they’re not as smart as the rest of us? Well, if you go on doing that for long enough, you probably do end up with the cream of the crop going to higher-paying jobs in the private sector.

Which means it’s not just a matter of fairness. Underpay your nurses and teachers and then wonder why you can’t get enough recruits.

Yes, but how will Minns possibly pay for those higher wages? He could cut the number of nurses and teachers he can afford to employ, but I doubt he will.

No, he’ll do what a business would do: raise his prices. Except that, in government, prices are called taxes. You want the workers? You pay the going rate. It’s the capitalist way.

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Both sides exaggerate significance of wage bargaining changes

Do you realise, in just the six months it’s been in office, the Albanese government has passed 61 bills, covering most of what it promised to do at the May election?

Just last week it passed the National Anti-Corruption Commission Bill and the controversial Secure Jobs, Better Pay bill. According to Anthony Albanese, the latter involved “the biggest workplace reforms since the 1970s” and its passing made last Friday “a huge day for working Australians”.

Sorry, this government’s degree of effort and expedition far exceeds anything achieved by its predecessor and some of its measures are truly memorable, but its industrial relations changes are nothing like that monumental.

For one thing, Albanese has yet to act on his promises to regulate the gig economy, act decisively to reduce wage theft and reduce the use of casuals and labour-hire companies.

But it’s not just Albanese who’s been laying it on too thick. Indeed, the prize for the biggest storm-in-a-teacup of the year must surely go to the Secure Jobs, Better Pay bill. Its passing was certainly “controversial” – the enormous fuss made by the various employer groups made sure of that – but the degree of controversy generated is an unreliable guide to the likely threat – or promise – from the changes made.

Two fearless predictions. First, the changes won’t be nearly as bad as the lobbyists’ scaremongering claimed. But equally, they won’t have nearly as much effect on the jobs and pay of “working Australians” as the government wants us to believe.

The employer groups’ repeated claims that the government’s efforts to increase the scope for “multi-employer bargaining” would lead to widespread strikes and job losses seems intended to bamboozle those not old enough to remember industrial relations when they really were red in tooth and claw.

Strike action peaked in the 1970s, when the number of strikes averaged 2370 a year, with total days of work lost averaging 3.1 million a year, and days lost per 1000 workers averaging 540. As in all the rich countries, strike action has declined markedly since then, with the 2010s seeing only 200 strikes per year, costing 145,000 days lost, or 14 days per 1000 workers.

The notion that Albanese’s modest changes will return us to anything remotely approaching the 1970s is risible.

In those days, when inflation was far higher than it is now, our long-gone system of compulsory arbitration had the perverse effect of encouraging many quite short strikes. These days, old IR hands know that if a strike lasts more than a day or two it’s a sign the union has lost. It will then take years for whatever small pay rise the workers end up getting to make up for the many days’ pay they lost.

Ask yourself this: how are widespread strikes supposed to lead directly to widespread job losses? They don’t. They lead to some workers losing their jobs only because the majority who don’t lose their jobs are getting wage rises so big that employers genuinely can’t afford them. It’s not a reasoned argument, it’s an attempt to frighten the unthinking.

What employers really fear is a move from bargaining at the level of the individual business or enterprise to bargaining at an industry-wide level, which would make it easier for the unions to achieve pay rises in businesses with few union members.

Although industry-wide bargaining remains outlawed by the Fair Work Act, the employer groups have chosen to pretend that the government’s cautious extension of access to multi-enterprise bargaining is pretty much the same thing.

Nonsense. As Adelaide University’s Professor Andrew Stewart explains, the new provision for “single- (or common-) interest” multi-employer bargaining is hedged about with limitations and protections. Unions will not be able to rope in small businesses employing fewer than 20 workers. Larger employers can only be included without their consent if a majority of their workers wants to bargain.

Access to this form of bargaining must be approved by the Fair Work Commission, which will permit employers to participate only if they are sufficiently “comparable” to the other employers. An employer with an existing single-enterprise agreement won’t be able to switch to a multi-employer agreement.

But those employers included in such bargaining will be required to bargain in “good faith” – be genuinely committed to reaching an agreement, and unions will be permitted to strike – provided this is approved by a secret ballot of employees.

A significant change is that, when either single- or multi-enterprise bargaining becomes intractable, the commission will resolve the dispute by arbitration.

The other new provision for “supported bargaining” of multi-employer agreements is aimed at helping low-paid workers in strongly female industries such as childcare and aged care. This is likely to produce some significant pay rises. Why? Because the “support” will come from the third party that will end up covering the cost of the pay rise – the federal government.

Apart from that, the low union membership in most of the relevant enterprises says there’ll be few strikes and few big pay rises.

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If only Labor's wage changes were as bad as the bosses claim

Have you ever wondered why capitalism has survived for several centuries in the advanced economies? How a relative handful of rich families and company executives have been getting richer and more powerful for so long in countries where everyone gets a vote and could, if they chose, insist on something different?

It’s because the capitalists, counselled and coerced by politicians anxious to keep the peace, have made sure that the plebs, punters and ordinary working families have been given enough of the spoils to keep them reasonably content.

I remind you of this because, for 30 or 40 years in America, and now about a decade in Australia, the capitalist system – economists prefer calling it the market system – hasn’t been giving ordinary workers enough to keep them getting better off, while the few people at the top of the tree have been doing better, year after year.

If you wonder why so many Americans voted for a man like Donald Trump, and now delude themselves that he didn’t lose the last election, why the Yanks seem to be rapidly dismantling their democracy, a big part of their discontent is their loss of faith that the economic system is giving them a fair shake.

Fortunately, it’s nothing like that bad in Australia. Not yet, anyway. What’s true is that the average standard of living in Australia today is no better than it was a decade ago – something that hasn’t happened before in the more than 75 years since World War II.

Over the eight years before the pandemic, wages rose barely faster than inflation. We’ve had wage stagnation, now made a lot worse by the supply-chain disruptions of the pandemic, soaring electricity and gas prices caused by Russia’s war, and by the way floods keep wiping out our fruit and vegetable crops.

When Labor went to this year’s federal election promising to “get wages moving”, I think it struck a chord with many voters.

After we ended centralised wage-fixing by the Industrial Relations Commission in the early 1990s, we moved to collective bargaining at the level of the individual enterprise. Workers’ right to strike was hedged about with many requirements and limits.

At the beginning, more than 40 per cent of workers were covered by enterprise agreements. By now, however, some academic experts calculate that the proportion of workers covered by active agreements is down to about 15 per cent.

At the jobs and skills summit in September, all sides agreed that the enterprise bargaining system had broken down. Last week the government introduced its answer to wage stagnation, the Secure Jobs, Better Pay bill.

It would make a host of changes, many of which strengthen existing provisions of the Fair Work Act, and most of which the industrial parties agree would be improvements. It makes job security and gender pay equity explicit goals of the act, prohibits sexual harassment and requirements that workers keep their pay secret, and strengthens the right of workers with family responsibilities to request flexible working hours. More debatably, it abolishes the Australian Building and Construction Commission.

To repair enterprise bargaining, it clarifies the BOOT – better off overall test – requiring that agreements leave no worker worse off. This was the Business Council’s greatest complaint against enterprise agreements.

One reason such agreements now cover so few workers is that they’re expensive and complex for small and middle-size employers to organise. Hence, the proposal to widen the existing provision for “multi-employer bargaining”: workers in similar enterprises allowed to bargain collectively with a number of employers.

This would widen access to enterprise bargaining. It’s aimed particularly at strengthening the bargaining position of women in low-paid jobs in the aged care, childcare and disability care sector.

Ambit claims and exaggerated rhetoric are standard fare in industrial relations, but the cries of fear and outrage coming from the various employer groups are over the top.

It would “create more complexity, more strikes and higher unemployment,” said one. It was “so fatally flawed” it would “emasculate enterprise bargaining”, according to another outfit. It was “seismic” in its impact, claimed a third.

Methinks they doth … I’d be amazed if they actually believe that stuff. They’re probably still adjusting to the shock of having the unions back in the government tent. They know they won’t be able to stop the bill being passed, so they want at least to be seen opposing it with all their voice.

What changing the law won’t change is that the proportion of workers in a union has fallen from 50 per cent to 14 per cent. The small and middle-size businesses we’re talking about have even fewer union members than that.

No union members, no strike. No strike, no big pay rise. In any case, really powerful unions get big pay rises without needing to strike.

This is an attempt to make bargaining provisions that didn’t work last time, work this time. I doubt if these modest changes will do much to “get wages moving” again. More’s the pity. If I’m right, Australia’s capitalism will remain broken.

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Summit consensus: everyone wins some, loses some

In the consensus spirit of dear departed Bob Hawke, Anthony Albanese is hoping it will be all sweetness and light at this week’s jobs and skills summit. And, to give them their due, the industrial parties have been doing their best, looking to realise John Howard’s maxim: “the things that unite us are greater than the things that divide us”.

The ACTU has issued a joint statement with the peak small business organisation expressing their agreement to “come together to explore ways to simplify and reduce complexity within the industrial relations system”.

The ACTU has also issued a joint statement with the Business Council – representing the nation’s biggest companies – and the two biggest employer groups. They all agree that federal and state governments should try harder and spend a lot more money fixing the almighty mess they’ve made of what they call “vocational education and training” but is actually what’s left of TAFE.

And the ACTU and the Business Council have issued a joint statement with the peak community welfare organisation, the Australian Council of Social Service, agreeing that the guiding framework of the summit should be “achieving and sustaining full employment”.

The Hawke government’s consensus summit succeeded because it sought a comprehensive, grand bargain in which each side gained something it wanted, while giving up things the others wanted.

Of course, no one knew more about hammering out a deal between warring parties than Hawke. I hope Albanese can rise to the occasion because, underneath all the smiling goodwill, the parties’ objectives in attending the summit seem diametrically opposed.

The main thing the unions want is a return to industry-wide, or at least multi-employer, wage bargaining because, under enterprise-level bargaining, they’ve lacked the industrial muscle to achieve decent pay rises. In contrast, the Business Council is desperate for a surge in migration to fill the present record number of job vacancies. Why? So big business doesn’t have to pay higher wages to attract the workers they need.

The council agrees that enterprise bargaining is broken, but what it means is that its members are finding it too hard to use the bargaining system to get their workers to agree to changes in the work they do in return for a pay rise.

Almost to a person, the nation’s economists are strong supporters of high levels of immigration. But the Economic Society of Australia’s recent survey of 50 top economists suggests their support has become more qualified.

Asked which of the policies likely to be discussed at the summit they considered to be of most benefit to Australians, only about a third picked “migration”, whereas almost two-thirds picked “education and skills”.

Independent economist Saul Eslake said he was “absolutely not an advocate of reducing our immigration intake” but he “didn’t think we should revert to being as reliant on it as a substitute for doing a better job of equipping those who are already here with the skills which will be required to obtain secure employment and decent wages in the years ahead”.

“Australia’s education system – at all levels – is increasingly failing to equip Australians with the skills required for the jobs of both today and the future,” he said. “As a result of the shortcomings in our education and training systems, we have become increasingly reliant on immigration to deliver skilled workers.”

Well, that’s one way to look at it. I think businesses have tolerated governments’ dismantling of higher education because, as part of their mania for lowering labour costs, they’ve found it easier and cheaper to import the already-trained labour they need.

Professor Sue Richardson, of Flinders University, said she thought that “judicious migration is very beneficial to the economic and social life of Australia”.

But we’ve “relied much too heavily on migration as a solution to any labour supply problem”. This “enables employers and our skills-development system to avoid a close examination of why we do not generate the skills that we need, and what needs to be done to ensure that we do”.

It seems the government is working towards increasing our immigration targets to please business and ease labour shortages, but in return for greater business support for technical training. And for higher wage rates for skilled workers on temporary visas, to limit the scope for undercutting the wages of local workers.

But Eslake suspects immigration may not return to pre-pandemic levels, at least not as quickly as widely assumed. I do too.

As for the wage-fixing arrangements, I think that’s what the ACTU will take away from the summit. Something has to be done to reduce the power imbalance between employers and employees, if the economy is to thrive.

It turns out enterprise bargaining suits big business, but not small business. The unions and the small business peak body have already agreed to explore a move to multi-employer bargaining.

With industry bargaining, firms don’t have to worry about agreeing to higher wages than their competitors are paying. You’d think that, in time, the nation’s big businesses would also see this advantage.

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Jobs summit: shut up those playing the productivity three-card trick

Anthony Albanese and his ministers are keen to ensure this week’s jobs and skills summit doesn’t degenerate into the talk fest the opposition is predicting it will be. Well, one way to avoid much hot air is to shut up people playing the usual three-card trick on productivity.

The truth is there’s a lot of muddled and dishonest talk about the relationship between wages and productivity. Much of this comes from the employer lobby groups, which will spout any pseudo-economic nonsense that suits their goal of keeping wage growth as low as possible.

But they get too much comfort from econocrats who think that if you know what economics 101 teaches about how demand and supply interact, you know all you need to know about how all markets work, including the labour market.

As former top econocrat Dr Michael Keating, an economist specialising in the labour market, has explained, “the authorities’ model, which assumes perfect competition, constant returns to scale and neutral technological progress, implies that real wages can be expected to grow at the same rate as [labour] productivity, neither more nor less, making it look as if the collapse in productivity growth explains the collapse in wages growth”.

So when workers complain about the lack of growth in real wages, the employers’ professional apologists reply that real wages haven’t grown because the productivity of labour hasn’t improved. If only the unions would co-operate in efforts to improve productivity, wages would grow, as sure as night follows day.

But the supposed magical mechanism by which productivity improvement flows inexorably to real wages is refuted by the summary statistics quoted in Treasury’s issues paper for the summit. We’re told that, though productivity improvement has slowed, we’ve still achieved growth averaging 1 per cent a year since 2004.

But we’re also told that “real wages have grown by only 0.1 per cent a year over the past decade, and have declined substantially over the past year”. Not much automatic flow-through there.

Which brings us to another thing that’s being fudged in the present debate. You sometimes hear spruikers for the employers implying you need productivity improvement to justify even a rise in nominal wages.

But productivity is a “real” – after-inflation – concept. For the benefit from national productivity improvement to be shared fairly between capital and labour – employers and employees – it has to increase wages over and above inflation.

Here, however, is where we strike another difficulty. There used to be tripartite consensus – business, workers and government – that wages should always keep up with prices. Cuts in real wages were needed only to correct a period where real wage growth had been excessive – that is, exceeding productivity improvement.

Right now, however, the opposite is the case. Real wages were long falling short of what productivity improvement we were achieving before the present surge in prices left wage rates far behind. Even with the labour market so tight, workers simply haven’t had the industrial muscle to achieve wage rises commensurate with the leap in prices.

And now, while businesses show little restraint in passing their higher imported input costs through to higher retail prices, while adding a bit for luck, the great and good – read business and the econocrats – have agreed that the quickest and easiest way to get inflation down is for the nation’s households to pay the price.

A big fall in real wages squares the circle. Business has passed on its costs – and then some – and the economic managers have redeemed their reputations and got the inflation rate falling back. What’s not to like?

Well, we’ve solved the problem by allowing a big cut in real household income. It’s likely businesses will feel adverse effects as households see no choice but to tighten their belts. And I imagine some workers, consumers and voters will be pretty upset, concluding that the economy certainly isn’t being run for their benefit.

In effect, Treasury’s issues paper says forget the present disaster and look to the future. We can get real wages growing again – an election promise - as soon as we get productivity up.

Well, no we can’t. The paper’s claiming that, contrary to the experience of the past decade, improved productivity automatically flows through to real wages. And even if that were true, it assumes workers are innumerate, and won’t know that future real gains in wages must first make up for previous real losses. It’s the productivity three-card trick.

Meanwhile, business and the econocrats’ self-serving expedience, in deciding that the punters should pay for a problem they did nothing to cause, has created the climate for radical reform of the wage-fixing system: a return to industry bargaining.

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Inflation psychology: firms charge what they can get away with

Economists think inflation is all about economics. What they don’t know is that it’s also about psychology. But Reserve Bank governor Dr Philip Lowe shows a glimmer of understanding when he refers not to “inflation expectations” but to “inflation psychology”.

Notorious for their “physics envy” – where the world works according to known and unchanging laws, so everything can be reduced to mathematical calculation – economists think changes in prices are determined by the interaction of the “laws” of supply and demand.

This is true, but far from the whole truth. Especially for the prices set in the jobs market – aka wages – where this simple “neoclassical” analysis almost always gives wrong answers.

Economists’ first attempt at a less mechanical approach to the relatively modern problem of inflation – a continuing rise in the general level of prices – came from Milton Friedman and another Nobel laureate’s realisation of the important role played by people’s expectations about what will happen to the inflation rate.

If it worsens significantly and this leads enough people to expect it to stay high or go higher, their expectations may lead to the higher rate becoming entrenched via a “wage-price spiral”.

That is, expectations of higher inflation tend to be self-fulfilling because people act on their expectations. If businesses expect higher price rises generally, they adjust their own prices accordingly. And workers and their unions adjust their own wage demands accordingly.

When last the rich world had a big inflation problem, in the second half of the 1970s and much of the ’80s, this theory seemed to work well, though it took years for expectations to worsen. Then it took years of keeping interest rates high and demand weak, and getting actual inflation down below 3 per cent, before expected inflation came back down.

The inflation target, of 2 to 3 per cent on average, was set in the mid-90s to help “anchor” expectations at an acceptable level.

All this is why the latest leap in inflation has led some economists to worry that, if expectations become “unanchored”, inflation may become entrenched at a much higher level.

This fear explains why many are anxious to use higher interest rates to get actual inflation back down ASAP. If falling real wages help to speed the process, so much the better.

Two small problems with this. For a start, there’s little evidence – either here or in the other rich economies – that expectations have moved up. Sensibly, everyone expects that, before too long, the inflation rate will go back to being a lot lower.

In the real world of price-setting by firms and workers, it takes a lot longer for expectations to shift prices than it does for prices in share and other financial markets to bounce around.

But the deeper reason worries about worsening expectations are misplaced is that, since this theory became so influential in the ’70s, the mechanism by which the expected inflation rate becomes the actual rate has broken down.

Businesses retain the ability to raise their prices when they decide to – and to discount those prices should they discover they’ve pushed it too far and are losing sales - but organised workers have largely lost their ability to force employers to grant higher pay rises.

If you doubt that, ask yourself why the number of days lost to strikes is now the tiniest fraction of what it was in the ’70s. We’ve seen a little strike action lately, but it’s coming almost wholly from workers in the public sector – the main part of the workforce that’s still heavily unionised.

But the breakdown of the inflation-expectations theory and the “wage-price spiral” as explanations of the relatively modern phenomenon of inflation – a continuing rise in the general level of prices – leaves us looking elsewhere for explanations.

A big part of it is the message those economists who specialise in studying competition have to give financial economists such as Lowe: you don’t seem to realise that our modern oligopolised economy gives many big businesses a lot of power over the prices they’re able to charge.

Oligopoly is about the few huge firms dominating a particular market reaching a tacit agreement to keep prices high and stable, and limit their competition for market-share to non-price areas such as product differentiation and marketing.

As former competition czar Rod Sims has pointed out, this greatly reduces the ability of higher interest rates to influence prices in many big slabs of the economy.

But if many big businesses can improve their profitability by deciding to raise their prices, why did they wait until only a year ago to decide to start whacking up them up? Because it ain’t that simple.

All firms would like to raise their prices all the time. What stops them is the knowledge that they can’t charge more than “what the market will bear”. They worry about two things: what will my competitors do? And what will my customers do?

When there’s a big rise in input costs, the knowledge that all my competitors are facing the same cost increase gives me confidence we’ll all be passing it through to the customer at the same time.

That’s why it was the sudden, large and widespread increase in the cost of imported inputs caused by the pandemic and the Ukraine war that started the latest bout of prices rises at the retail level.

But, as Lowe keeps saying, the supply chain cost increases don’t explain all the rise in retail prices. He makes the obvious point that firms find it easier to raise their prices at a time when demand is strong and people are spending. His interest-rate rises are intended to stop demand being so strong and conducive to price rises.

But the less obvious point – especially to people mesmerised by the neoclassical way of thinking – is the role of psychology. I’ve got a great justification for increasing my prices, but no one’s counting. If my costs have risen by 5 per cent, but I increase my prices by 6 per cent, who’s to know?

Sims reminds us that this is just the way firms with pricing power behave. They raise their prices and profits in ways that aren’t easy for their customers to notice.

That covers big business. In the main, small businesses don’t have much pricing power. But “what the market will bear” is greater when the media has spent months softening up their customers with incessant talk about inflation and how high prices will go.

Lowe can’t say it, but it’s not uncooperative workers that are his problem, it’s businesses using the chance to slip in a little extra for themselves.

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The inflation fix: protect profits, hit workers and consumers

There’s a longstanding but unacknowledged – and often unnoticed – bias in mainstream commentary on the state of the economy. We dwell on problems created by governments or greedy workers and their interfering unions, but never entertain the thought that the behaviour of business could be part of the problem.

This ubiquitous pro-business bias – reinforced daily by the national press – is easily seen in the debate on how worried we should be about inflation, and in the instant attraction to the notion that continuing to cut real wages is central to getting inflation back under control. This is being pushed by the econocrats, and last week’s economic statement from Treasurer Jim Chalmers reveals it’s been swallowed by the new Labor government.

I’ve been arguing strongly that the primary source of the huge price rises we’ve seen is quite different to what we’re used to. It’s blockages in the supply of goods, caused by a perfect storm of global problems: the pandemic, the war in Ukraine and even climate change’s effect on meat and vegetable prices.

Since monetary policy can do nothing to fix supply problems, we should be patient and wait for these once-off, temporary issues to resolve themselves. The econocrats’ reply is that, though most price rises come from deficient supply, some come from strong demand – and they’re right.

Although more than half the 1.8 per cent rise in consumer prices in the June quarter came from just three categories – food, petrol and home-building costs – it’s also true there were increases in a high proportion of categories.

The glaring example of price rises caused by strong demand is the cost of building new homes. Although there have been shortages of imported building materials, it’s clear that hugely excessive stimulus – from interest rates and the budget – has led to an industry that hasn’t had a hope of keeping up with the government-caused surge in demand for new homes. It’s done what it always does: used the opportunity to jack up prices.

But as for a more general effect of strong demand on prices, what you don’t see in the figures is any sign it’s high wages that are prompting businesses to raise their prices. Almost 80 per cent of the rise in prices over the year to June came from the price of goods rather than services. That’s despite goods’ share of total production and employment being about 20 per cent.

This – along with direct measures of wage growth - says it’s not soaring labour costs that have caused so many businesses to raise their prices. Rather, strong demand for their product has allowed them to pass on, rather than absorb, the higher cost of imported inputs – and, probably, fatten their profit margins while they’re at it.

Take the amazing 7 per cent increase in furniture prices during the quarter. We’re told this is explained by higher freight costs. Really? I can’t believe it.

Nor can I believe that months of unrelenting media stories about prices rising here, there and everywhere – including an open mic for business lobbyists to exaggerate the need for price rises – haven’t made it easier for businesses everywhere to raise their prices without fear of pushback from customers.

But whenever inflation worsens, the economists’ accusing fingers point not to business but to the workers. No one ever says businesses should show more restraint, they do say the only way to fix the problem is for workers to take a real-wage haircut.

There’s no better evidence of the economics profession’s pro-business bias than its studious avoidance of mentioning the way the profits share of national income keeps rising and the wages share keeps falling.

In truth, the story’s not as simple as it looks, but it seems to have occurred to no mainstream economist that what may be happening is business using the cover of the supply-side disruptions to effect a huge transfer of income from labour to capital.

Allowing real wages to fall significantly for three years in a row – as Chalmers’ new forecasts say they will – would certainly be the quickest and easiest way to lower inflation, but do the econocrats really imagine this would leave the economy hale and hearty?

Yet another sign of economists’ pro-business bias is that so few of them know much – or even think they need to know much – about how wages are fixed in the real world. Hence all the silliness we’re hearing about the risk of lifting inflation expectations. Can’t happen when workers lack bargaining power.

You’d think an understanding of wage-fixing is something a Labor government could bring to the table. But no. All we’re getting from Chalmers is that we need to cut real wages so we can increase them later. Yeah, sure.

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Business volunteers its staff to take one for the shareholders' team

An increase in wages sufficient to prevent a further fall in real wages would do little harm to the economy and much good to businesses hoping their sales will keep going up rather than start going down.

It’s hard enough to figure out what’s going on in the economy – and where it’s headed – without media people who should know better misrepresenting what Reserve Bank governor Dr Philip Lowe said last week about wages and inflation.

One outlet turned it into a good guys versus bad guys morality tale, where Lowe rebuked the evil, inflation-mongering unions planning to impose 5 or 7 per cent wage rises on the nation’s hapless businesses by instituting a “3.5 per cent cap” on the would-be wreckers, with even the new Labor government “bowing” to Lowe’s order that real wages be cut, and the ACTU “conceding” that 5 per cent wage claims would not go forward.

ACTU boss Sally McManus was on the money in dismissing this version of events as coming from “Boomer fantasy land”. What she meant was that this conception of what’s happening today must have come from the mind of someone whose view of how wage-fixing works was formed in the 1970s and ’80s, and who hadn’t noticed one or two minor changes in the following 30 years.

No one younger than a Baby Boomer could possibly delude themselves that workers could simply demand some huge pay rise and keep striking – or merely threatening to strike – until their employer caved in and granted it.

Or believe that, as really was the case in the 1970s and 1980s, the quarterly or half-yearly “national wage case” awarded almost every worker in the country a wage rise indexed to the consumer price index. Paul Keating abolished this “centralised wage-fixing system” in the early ’90s and replaced it with collective bargaining at the enterprise level.

John Howard’s changes, culminating in the Work Choices changes in 2005, took this a lot further, outlawing compulsory unionism, tightly constraining the unions’ ability to strike, allowing employers to lock out their employees, removing union officials’ right to enter the workplace and check that employers were complying with award provisions (now does the surge in “accidental” wage theft surprise you?) and sought to diminish employees’ bargaining power by encouraging individual contracts rather than collective bargaining.

Julia Gillard’s Fair Work changes in 2009 reversed some of the more anti-union elements of Work Choices but, as part of modern Labor’s eternal desire to avoid getting off-side with big business, let too many of them stand.

As both business and the unions agree, enterprise bargaining is falling into disuse. On paper, about a third of the nation’s employees are subject to enterprise agreements. But McManus claims that, in practice, it’s down to about 15 per cent.

All these changes in the “institution arrangements” for wage-fixing are before you take account of the way organised labour’s bargaining power has been diminished by globalisation and technological change making it so much easier to move work – particularly in manufacturing, but increasingly in services – to countries where labour is cheaper.

In the ’80s, about half of all workers were union members. Today, it’s down to 14 per cent, with many of those concentrated in public sector jobs such as nursing, teaching and coppering.

All this is why fears that we risk returning to the “stagflation” of the 1970s are indeed out of fantasy land. Only a Boomer who hasn’t been paying attention, or a youngster with no idea of how much the world has changed since then, could worry about such a thing.

The claim that Lowe has stopped the union madness in its tracks by imposing a “3.5 per cent cap” on wage rises misrepresents what he said. It ignores his qualification that 3.5 per cent – that is, 2.5 per cent as the mid-point of the inflation target plus 1 per cent for the average annual improvement in the productivity of labour – is “a medium-term point that I’ve been making for some years” (my emphasis) that “remains relevant, over time,” (ditto) and is the “steady-state wage increase”.

Like the inflation target itself, it’s an average to be achieved “over the medium term” – that is, over 10 years or so – not an annual “cap” that you can fall short of for most of the past decade, but must never ever exceed.

Supposedly, it’s a “cap” because of Lowe’s remark that “if wage increases become common in the 4 to 5 per cent range, then it’s going to be harder to return inflation to 2.5 per cent.”

That’s not the imposition of a cap – which, in any case, Lowe doesn’t have to power to do, even if he wanted to – it’s a statement of the bleeding obvious. It’s simple arithmetic.

But it’s also an utterly imaginary problem. It ain’t gonna happen. Why not? Because, as McManus “conceded”, no matter how unfair the unions regard it to force workers to bear the cost of the abandon with which businesses have been protecting their profits by whacking up their prices, workers simply lack the industrial muscle to extract pay rises any higher than the nation’s chief executives can be shamed into granting.

While we’re talking arithmetic, however, don’t fall for the line – widely propagated – that if prices rise by 5 per cent, and then wages rise by 5 per cent, the inflation rate stays at 5 per cent. As the Bureau of Statistics has calculated, labour costs account for just 25 per cent of all business costs.

So, only if all other, non-labour costs have also risen by 5 per cent does a 5 per cent rise in wage rates justify a 5 per cent rise in prices, thus preventing the annual inflation rate from falling back.

In other words, what we’re arguing about is how soon inflation falls back to the target range. Commentators with an unacknowledged pro-business bias (probably because they work for big business) are arguing that it should happen ASAP by making the nation’s households take a huge hit to their real incomes. This, apparently, will be great for the economy.

Those in the financial markets want to hasten the return to target by having the Reserve raise interest rates so far and so fast it puts the economy into recession. Another great idea.

Meanwhile, Lowe says he expects the return to target inflation to take “some years”. What a wimp.

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