What's kept us from full employment is a bad idea that won't die

Lurking behind the employment white paper that Treasurer Jim Chalmers will release today is the ugly and ominous figure of NAIRU – the non-accelerating-inflation rate of unemployment. If the Albanese government can’t free itself and its econocrats from the grip of NAIRU, all its fine words about the joys of full employment won’t count for much.

The NAIRU is an idea whose time has passed. It made sense once, but not anymore. The story of how this conventional wisdom came to dominate the thinking of the rich world’s macroeconomists has been told by Queensland University’s Professor John Quiggin.

In the period after World War II, economists decided that the managers of the economy faced a simple choice between inflation and unemployment. Low unemployment came at the cost of high inflation, and vice versa.

This relationship was plotted on something called the Phillips curve, and the economic managers could choose which combination of inflation and unemployment they wanted.

It seemed to work well enough until the mid-1970s, when the developed economies found themselves with high unemployment and high inflation at the same time – “stagflation” – something the Phillips curve said couldn’t happen.

The economists turned to economist Milton Friedman, who’d been arguing that, if inflation persisted long enough, the expectations of workers and businesses would adjust. The inflation rate would become “baked in” as workers and suppliers increased their wages and prices by enough to compensate for inflation, whatever the unemployment rate.

So, after much debate, the economists moved to doing regular calculations of the NAIRU – the lowest rate to which unemployment could fall before shortages of labour pushed up wages and so caused price inflation to take off.

Since the early 1980s, the economic managers have tried to ensure the rate of unemployment stayed above the estimated NAIRU, so inflation would stay low. Should inflation start worsening, central bankers would jump on it quickly by whacking up interest rates.

Why? So that expectations about inflation would stay "anchored". Should they rise, the spiral of rising wages leading to rising prices would push up actual inflation. Then it would be the devil’s own job to get it back down.

If this sound familiar, it should. It’s what the Reserve Bank has been warning about for months.

Trouble is, the theory no longer fits the facts. Inflation has shot up, but because of supply disruptions, plus the pandemic-related budgetary stimulus, not excessive wage growth. And there’s been no sign of a worsening in inflation expectations.

Wages have risen in response to the higher cost of living, but have failed to rise by anything like the rise in prices. Why? Because, seemingly unnoticed by the econocrats, workers’ bargaining power against employers has declined hugely since the 1970s.

Meanwhile, the stimulus took us down to the lowest rate of unemployment in almost 50 years, where it’s stayed for more than a year. It’s well below estimates of the NAIRU, meaning wages should have taken off, but shortage-driven pay rises have been modest.

All of which suggest that the NAIRU is an artifact of a bygone age. As Quiggin says, the absence of a significant increase in wage growth is inconsistent with the NAIRU, which was built around the idea that inflation was driven by growth in wages, passed on as higher prices.

“As a general model of inflation and unemployment, it is woefully deficient,” Quiggin concludes.

Economists have fallen into the habit of using their calculations of an ever-changing NAIRU as their definition of full employment. But it’s now clear that, particularly in recent years, this has led us to accept a rate of unemployment higher than was needed to keep inflation low, thus tolerating a lot of misery for a lot of people.

So if today’s employment white paper is to be our road map back to continuing full employment – if our 3.5 per cent unemployment rate is to be more than a case of ships passing in the night – we must move on from the NAIRU.

A policy brief from the Australian Council of Social Service makes the case for new measures of full employment and for giving full employment equal status with the inflation target in the Reserve Bank’s policy objectives – as recommended by the Reserve Bank review.

The council quotes with approval new Reserve governor Michele Bullock’s definition that “full employment means that people who want a job can find one without having to search for too long”.

But it says another goal could be added, that “people who seek employment but have been excluded (including those unemployed long-term) have a fair chance of securing a job with the right help”.

And it argues that “since an unemployment rate of 3.5 per cent (and an underemployment rate of 6 per cent) has not triggered strong wages growth, this could be used as a full employment benchmark”.

One of the things wrong with the NAIRU was that it was a calculated measure, and it kept changing. As Quiggin notes, it tends to move in line with the actual rate of unemployment.

“When unemployment was high, estimates of NAIRU were high. As it fell, estimates of NAIRU fell, suggesting that how far unemployment could fall was determined by how far unemployment had fallen,” he says.

Which is why, to the extent that econocrats persist with their NAIRU estimates – or the government sets a more fixed target – the council is smart to suggest a test-and-see approach.

Rather than continuing to treat a fallible estimate as though it’s an electrified fence – to be avoided at all cost – you allow actual unemployment to go below the magic number, and see if wages take off. Only when they do, do you gently apply the brakes.

The council reminds us that it’s not enough to merely aspire to full employment, or even specify a number for it. It’s clear that, apart from the ups and downs of the business cycle, what keeps unemployment higher than it should be is long-term unemployment.

Committing to full employment should involve committing to give people who have “had to search too long” special help just as soon as their difficulties become apparent.

This would be a change from paying for-profit providers of government-funded “employment services” to punish them for their moral failings.

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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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Big business should serve us, not enslave us

When my brain was switching to idle on my recent break, I thought of two central questions. First, for whose benefit is the economy being run – a handful of company executives at the top, or all the rest of us? Second, despite all the hand-wringing over our lack of productivity improvement, would it be so terrible if the economy stopped growing?

Then the whole Qantas affair reached boiling point. So we’ll save the economy’s growth for another day.

You’ve probably heard as much as you want to know about Qantas and its departed chief executive Alan Joyce. But Qantas’ domination of our air travel industry makes its performance of great importance to our lives. And Qantas is just the latest and most egregious case of Big Business Behaving Badly.

We’ve seen all the misconduct revealed by the banking royal commission, with the Morrison government accepting all the commission’s recommendations before the 2019 election, then quietly dropping many of them after the election.

We’ve seen consulting firm PwC caught abusing the trust of the Tax Office, with further inquiry revealing the huge sums governments are paying the big four accounting firms for underwhelming advice on myriad routine matters.

We’ve seen Rio Tinto “accidentally” destroying a sacred site that stood in its way and, it seems, almost every big company “accidentally” paying their staff less than their legal entitlement.

Now, let’s be clear. I’m a believer in the capitalist system – the “market economy” as economists prefer to call it. I accept that the “profit motive” is the best way to motivate an economy. And that the exploitation of economies of scale means we benefit from having big companies.

But that doesn’t mean companies can’t get too big, nor that all the jobs and income big businesses bring us mean governments should manage the economy to please the nation’s chief executives.

It should go without argument that governments should manage the economy for the benefit of the many, not the few. The profit motive, big companies and their bosses should be seen as just means to the end of providing satisfying lives for all Australians, including the disabled and disadvantaged.

We allow the pursuit of profit, and the chosen treatment of employees and customers, only to the extent that the benefits to us come without unreasonable cost to us. Business serves us; we don’t serve it.

In other words, we need a fair bit of the benefit to “trickle down” from the bosses and shareholders at the top to the customers and workers at the bottom. That’s the unwritten social contract between us and big business. And for many years, enough of the benefit did trickle down. But in recent years the trickle down has become more trickle-like.

This is partly explained by the way the “micro-economic reform” of the Hawke-Keating government degenerated into “neoliberalism” – the belief that what’s good for BHP is good for Australia. This would have been encouraged by the way election campaigns have become an advertising arms race, with both sides of politics seeking donations from big business.

Another cause was explained by a former Reserve Bank governor, Ian Macfarlane, in his Boyer Lectures of 2006: “The combination of performance-based pay and short job tenure is becoming increasingly common throughout the business sector ... It can have the effect of encouraging managers to chase short-term profits, even if long-term risks are being incurred, because if the risks eventuate, they will show up ‘on someone else’s shift’.”

The upshot of neoliberalism’s assumption that business always knows best is to leave the nation’s chief executives – and their boardroom cheer squads – believing they’re part of a commercial Brahmin caste, fully entitled to be paid many multiples of what their fellow employees get, to retire with more bags of money than they can carry, and to have politicians never do anything that hampers their money-grubbing proclivities.

Their Brahminisation has reached the point where they think they can break the law with impunity. They’re confident that corporate watchdogs and competition and consumer watchdogs won’t come after them – or won’t be able to afford the lawyers they can.

Chief executives for years have used multiple devices – casualisation, pseudo contracting, labour hire companies, franchising and more – to chisel away at workers’ wages. And that’s before you get to the ways they quietly chisel their customers.

The fact is that the error and era of neoliberalism are over, but the Business Council and its members have yet to get the memo. They’re continuing to claim that cutting the rate of company tax would do wonders for the economy (not to mention their bonuses) and that the Albanese government’s latest efforts to protect employees from mistreatment would make their working arrangements impossibly “inflexible”.

But the more Qantases and Alan Joyces we call out while they amass their millions, the more the public wakes up, and the more governments see we want them to get the suits back under control.

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Jury still out on how much hip pocket pain still coming our way

It’s not yet clear whether the Reserve Bank’s efforts to limit inflation will end up pushing the economy into recession. But it is clear that workers and their households will continue having to pay the price for problems they didn’t cause.

Prime Minister Anthony Albanese didn’t cause them either. But he and his government are likely to cop much voter anger should the squeeze on households’ incomes reach the point where many workers lose their jobs.

And he’ll have contributed to his fate should he continue with his apparent intention to leave the stage-three income tax cuts in their present, grossly unfair form.

The good news is that we’re due to get huge hip pocket relief via the tax cuts due next July. The bad news is that the savings will be small for most workers, but huge – $170 a week – for high-income earners who’ve suffered little from the squeeze on living costs.

Should Albanese fail to rejig the tax cuts to make them fairer, you can bet Peter Dutton will be the first to point this out. But he’ll need to be quick to beat the Greens to saying it.

Those possibilities are for next year, however. What we learnt this week is how the economy fared over the three months to the end of June. The Australian Bureau of Statistics’ “national accounts” show it continuing just to limp along.

Real gross domestic product – the value of the nation’s production of goods and services – grew by only 0.4 per cent – the same as it grew in the previous, March quarter. Looking back, this means annual growth slowed from 2.4 per cent to 2.1 per cent.

If you know that annual growth usually averages about 2.5 per cent, that doesn’t sound too bad. But if you take a more up-to-date view, the economy’s been growing at an annualised (made annual) rate of about 1.6 per cent for the past six months. That’s just limping along.

And it’s not as good as it looks. More than all the 0.4 per cent growth in GDP during the June quarter was explained by the 0.7 per cent growth in the population as immigration recovers.

So when you allow for population growth, you find that GDP per person actually fell by 0.3 per cent. The same was true in the previous quarter – hence all the people saying we’re suffering a “per capita recession”.

As my colleague Shane Wright so aptly puts it, the economic pie is still growing but, with more people to share it, the slices are thinner.

It’s possible that continuing population growth will stop GDP from actually contracting, helping conceal from the headline writers how tough so many households are faring.

But the media’s notion that we’re not in recession unless GDP falls for two quarters in a row has always been silly. What makes recessions such terrible things is not what happens to GDP, but what happens to workers’ jobs.

It’s when unemployment starts shooting up – because workers are being laid off and because young people finishing their education can’t find their first proper job – that you know you’re in recession.

In the month of July, the rate of unemployment ticked up from 3.5 per cent to 3.7 per cent, leaving an extra 35,000 people out of a job. If we see a lot more of that, there will be no doubt we’re in recession.

But why has the economy’s growth become so weak? Because households account for about half the total spending in the economy, and they’ve slashed how much they spend.

Although consumer spending grew by 0.8 per cent in the September quarter of last year, in each of the following two quarters it grew by just 0.3 per cent, and in the June quarter it slowed to a mere 0.1 per cent.

Households’ disposable (after-tax) income rose by 1.1 per during the latest quarter but, after allowing for inflation, it actually fell by 0.2 per cent – by no means the first quarter it’s done so.

What’s more, it fell even though more people were working more hours than ever before. People worked 6.8 per cent more hours than a year earlier.

So why did real disposable income fall? Because consumer prices rose faster than wage rates did. Over the year to June, prices rose by 6 per cent, whereas wage rates rose by 3.6 per cent.

Understandably, people make a big fuss over the way households with big mortgages have been squeezed by the huge rise in interest rates. But they say a lot less about the way those same households plus the far greater number of working households without mortgages have been squeezed a second way: by their wage rates failing to rise in line with prices.​

This is why I say the nation’s households are paying the price for fixing an inflation problem they didn’t cause. It’s the nation’s businesses that put up their prices by a lot more than they’ve been prepared to raise their wage rates.

Businesses have acted to protect their profits and – in more than a few cases – actually increase their rate of profitability. In the process, they risk maiming the golden geese (aka customers) that lay the golden eggs they so greatly covet.

If you think that’s unfair, you’re right – it is. But that’s the way governments and central banks have long gone about controlling inflation once it’s got away. It was easier for them to justify in the olden days – late last century – when it was often the unions that caused the problem by extracting excessive wage rises.

But those days are long gone. These days, evidence is accumulating that the underlying problem is the increased pricing power so many of our big businesses have acquired as they’ve been allowed to take over their competitors and prevent new businesses from entering their industry.

The name Qantas springs to mind for some reason, but I’m sure I could think of others.

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Albanese's big chance to improve inflation, productivity and wages

Are Anthony Albanese and his ministers a bunch of nice guys lacking the grit to do much about their good intentions? Maybe. But this week’s announcement of a review of competition policy raises hope that the nice guys intend to make real improvements.

The review, which will provide continuous advice to the government over the next two years, has been set up because “greater competition [between Australia’s businesses] is critical for lifting dynamism, productivity and wages growth [and] putting downward pressure on prices”, Treasurer Jim Chalmers says.

As I wrote on Monday, the great weakness in our efforts to reduce high inflation has been our assumption that its causes are purely macroeconomic – aggregate demand versus aggregate supply – with no role for microeconomics: whether businesses in particular industries have gained the power to push their prices higher than needed to cover their increased costs.

But it seems Chalmers understands that. “Australia’s productivity growth has slowed over the past decade, and reduced competition has contributed to this – with evidence of increased market concentration [fewer businesses coming to dominate an industry], a rise in markups [profit margins] and a reduction in dynamism [ability to change and improve] across many parts of the economy,” he says.

The former boss of the Australian Competition and Consumer Commission, Rod Sims, had some pertinent comments to make about all this at a private business function last week.

He observes that “companies worked out long ago that the essence of corporate strategy is to gain market power and erect entry barriers. Profits from ‘outrunning’ many competitors from a common starting point are generally small; profits from gaining market power are usually large.

“Businesspeople know that when the number of competitors gets too large, price competition is often the result, and that this ‘destroys shareholder value’ or, alternatively put, helps consumers.”

Sims says the goals of growing and sharing the economic pie are being damaged in Western economies, and in Australia, by inadequate competition leading to market power. But, aside from the specialists, the economics profession more broadly has been slow to realise this and factor it into policy responses.

Australia has an extremely concentrated economy, Sims says. We have one dominant rail freight company operating on the east coast, one dominant airline with two-thirds of the market, two beer companies, two ice-cream sellers and two ticketing companies, all with a 90 per cent share of their markets.

We have two supermarkets with a combined market share of about 70 per cent. We have three dominant energy retailers and three dominant telecommunications companies. We have four major banks, with a 75 per cent share of the home mortgage market.

This is much greater concentration than in other developed countries. And, as you’d expect, the profit margins of these companies generally exceed those of comparable companies overseas.

The centuries that businesses have spent pursuing economies of scale explain why we don’t have – and shouldn’t want - the huge number of small firms assumed by the economic theory burnt on the brains of most economists.

But, Sims argues, our relatively small population doesn’t justify the much greater concentration of our industries. For one thing, studies of Australian industry sectors show that the returns to scale stop increasing well before market shares are anything like as high as they are in Australia.

For another, Australia’s modest size doesn’t explain why our industries are getting ever more concentrated, so that our key players are less likely to be challenged by competitors.

And it’s not just our high concentration, it’s also that we see large asset-managing institutions with big shareholdings in most of the firms dominating an industry. Thus, asset managers have an interest in keeping the whole industry’s profits high by limiting price competition between the companies.

One study, of 70,000 firms in 134 countries, found that the average prices charged by our listed companies were 40 per cent above the companies’ marginal cost of production in 1980, and about the same in the late 1990s. But by the early 2000s, average prices were 40 per cent above marginal cost. By 2010, they’d risen to 50 per cent above, and by 2016 it was nearly 60 per cent.

Analysis by federal Treasury has found that our companies’ markups increased over the 13 years to 2017.

The evidence in Australia and overseas is that in concentrated industries we see less dynamism, lower investment and lower productivity, Sims says. Our productivity performance has been very poor at a time when our focus on pro-competition public policy appears to have been lost.

It’s not hard to believe that the latter explains the former. “We run harder when competing versus when we run alone,” Sims says.

Our Treasury’s research also shows that firms in concentrated markets are further from the productivity frontier as there’s less incentive to keep up.

And market concentration also has implications for wage levels. Where labour mobility – the ease with which people move between employers – is reduced, wage levels are lower.

But high industry concentration means fewer firms that workers can move to, bringing relevant skills, and fewer new firms entering the industry. Less competition for workers means lower wages.

“Non-compete clauses” make the problem worse. Recent Australian studies have shown that more than one in five employees are prevented from working for competitors under such contract terms, often even in fairly low-skilled jobs.

Another finding is that the benefits of improved productivity are less shared with workers in concentrated industries. The share of productivity gains going to workers has declined by 25 per cent in the last 15 years, Sims says.

So next time some business person, politician, Reserve Bank governor or other economists tells you higher productivity automatically increases everyone’s wage, don’t fall for it. Used to be true; isn’t any more.

All this says that if the Albanese government is fair dinkum about getting inflation down and productivity and wages up, it will at least ban non-compete clauses and tighten up our merger laws.

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RBA's double whammy: hit wages and raise interest rates

If the sharp increase in interest rates we’ve seen leads to a recession, it will be the recession we didn’t have to have. The judgment of hindsight will be that the Reserve Bank’s mistake was to worry about wage growth being too high, when it should have worried about it being too low.

The underrated economic news this week was the Australian Bureau of Statistics’ announcement that its wage price index grew by 0.8 per cent over the three months to the end of June, and by 3.6 per cent over the year to June.

This was the third quarter in a row that wages had risen by 0.8 per cent, but annual growth was down a fraction from 3.7 per cent over the year to March. It was a slowdown the Reserve hadn’t expected.

So, the obvious question arises: is it good news or bad? Short answer: depends on your perspective. Long answer: keep reading.

The Reserve would have regarded the modest fall as good news because its focus is on getting the rate of inflation down to its 2 to 3 per cent target range as soon as reasonably possible. The slight lowering in wage growth will help in two ways.

First, it means a slightly smaller increase in businesses’ wage costs, which should mean they increase their prices by a little less.

Second, the slight fall in wage growth slightly increases the squeeze on households’ incomes, making it a little harder for them to keep spending as much on goods and services. The less the demand for their products, the less the scope for businesses to raise their prices.

It’s hardly a big change, obviously, but it’s in the right direction. It’s a sign the Reserve’s anti-inflation strategy is working and that the return to low inflation may happen a little earlier.

But what if you’re just a worker – is it good news or bad, from your perspective? Well, Treasurer Jim Chalmers would like to remind you that wage growth of 3.7 or 3.6 per cent is the highest we’ve had since mid-2012.

Not bad, eh? Trust Labor to get your wages up.

I trust you’re sufficiently economically literate to see through that one. Back then, the annual rate of inflation was about 2 per cent, whereas in June quarter this year it was 6 per cent – not long down from a peak of 7.8 per cent.

So wage growth of 3.6 per cent is hardly anything to boast about. Wages might be up, but prices are up by a lot more. Take account of inflation, and “real” wages actually fell by 2.4 per cent over the year to June.

Over the 11 years to June, consumer prices rose by 33 per cent, whereas the wage price index rose by 29 per cent. If you’re a worker, that’s hardly something to celebrate.

Why do ordinary people put up with the capitalist system, in which big business people are revered like Greek gods, permitted to lecture us on our many failings, and allowed to pay themselves maybe 40 times what an ordinary worker gets?

Because the punters get their cut. Because enough of the benefits trickle down to ordinary workers to give them a steadily improving standard of living. Because wages almost always rise a bit faster than prices do.

This is the “social contract” the rich and powerful have made with the rest of us for letting them call the shots. But for the past decade or more we’ve got nothing from the deal. Indeed, our standard of living has slipped back.

Don’t worry, say Chalmers and his boss Anthony Albanese, it won’t be more than a year or three before inflation’s down lower than wage growth and real wages are back to growing a bit each year.

Yeah, maybe. It’s certainly what should happen, it happened in the past, so maybe it will happen again. But one thing we can be sure of: we’re unlikely ever to catch up for the losing decade.

Throughout the Reserve’s response to the post-pandemic period, it’s had next to nothing to say about the abandon with which businesses have been whacking up their prices, while always on about the need for wage growth to be restrained.

It’s tempting to think that, in the mind of the Reserve, the only function wages serve is to help it achieve its inflation target. When inflation’s below the target, the Reserve wants bigger pay rises to get inflation up. When inflation’s above the target, it wants lower pay rises to get inflation down.

The truth is, the Reserve’s been mesmerised by the threat that roaring wages would pose to lower inflation. Its limited understanding of the forces bearing on wages is revealed by its persistent over-forecasting of how fast they will grow.

Once the unemployment rate began falling towards 3.5 per cent and the jobs market became so tight – with job vacancies far exceeding the number of unemployed workers – it has lived in fear of surging wages as employers bid up wages in their frantic efforts to hang on to or recruit skilled workers.

It just hasn’t happened. As we’ve seen, wages haven’t risen enough merely to keep up with prices, much less soar above them.

The Reserve has worried unceasingly that the price surge would adversely affect people’s expectations about inflation, leading to a wage-price spiral that would keep inflation high forever. This is why it’s kept raising interest rates and been rushing to see inflation fall back.

Again, it just hasn’t happened.

Normally, when inflation’s been surging and the Reserve has been raising interest rates to slow down our spending, real wages have been growing strongly. But not this time. This time, falling real wages have greatly contributed to the squeeze on households and their spending.

That’s why, if this week’s falling employment and rising unemployment continue to the point of recession, people will realise the Reserve’s mistake was to worry about wage growth being too high, when it should have worried about it being too low.

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Another rise in interest rates is enough already

Whatever decision the Reserve Bank board makes about interest rates at its meeting tomorrow morning – departing governor Dr Philip Lowe’s second-last – the stronger case is for no increase. Indeed, I agree with those business economists saying we’ve probably had too many increases already.

If so – and I hope I’m wrong – we’ll miss the “narrow path” to the sought-after “soft landing” and hit the ground with a bang. We’ll have the recession we didn’t have to have. (That’s where recession is measured not the lazy, mindless way – two successive quarters of “negative growth” – but the sensible way: a big rise in unemployment over just a year or so.)

For those too young to know why recessions are dreaded, it’s not what happens to gross domestic product that matters (it’s just a sign of the looming disaster) but what happens to people: lots of them lose their jobs, those leaving education can’t find decent jobs, and some businesses collapse.

Market economists usually focus on guessing what the Reserve will do, not saying what it should do. (That’s because they’re paid to advise their bank’s money-market traders, who are paid to lay bets on what the Reserve will do.)

That’s why it’s so notable to see people such as Deloitte Access Economics’ Stephen Smith and AMP’s Dr Shane Oliver saying the Reserve has already increased interest rates too far.

Last week’s consumer price index for the June quarter gave us strong evidence that the rate of inflation is well on the way down. After peaking at 7.8 per cent over the year to December, it’s down to 6 per cent over the year to June.

As we’ve been told repeatedly, this was “less than expected”. Yes, but by whom? Usually, the answer is: by economists in the money markets. Here’s a tip: what money-market economists were forecasting is of little interest to anyone but them.

That almost always proves what we already know: economists are hopeless at forecasting the economy. Even after the fact, and just a week before we all know the truth. No, the only expectation that matters is what the Reserve was expecting. Why? Because it’s the economist with its hand on the interest-rate lever.

So, it does matter that the Reserve was expecting annual inflation of 6.3 per cent. That is, inflation’s coming down faster than it thought. Back to the drawing board.

The Reserve takes much notice of its preferred measure of “underlying” inflation. It’s down to 5.9 per cent. But when the economy’s speeding up or slowing down, the latest annual change contains a lot of historical baggage.

This is why the Americans focus not on the annual rate of change, but the “annualised” (made annual) rate, which you get by compounding the quarterly change (or, if you can’t remember the compounding formula, by multiplying the number by four).

Have you heard all the people saying, “oh, but 6 per cent is still way above the target of 2 to 3 per cent”? Well, if you annualise the most recent information we have, that prices rose by 0.8 per cent in the June quarter, you get 3.3 per cent. Clearly, we’re making big progress.

But the next time someone tells you we’re still way above the target, ask them if they’ve ever heard of “lags”. Central Banking 101 says that monetary policy (fiddling with interest rates) takes a year or more to have its full effect, first on economic activity (growth in gross domestic product and, particularly, consumer spending), then on the rate at which prices are rising. What’s more, the length of the lag (delay) can vary.

This is why central bankers are supposed to remember that, if you keep raising rates until you’re certain you’ve done enough to get inflation down where you want it, you can be certain you’ve done too much. Expect a hard landing, not a soft one.

Since the road to lower inflation runs via slower growth in economic activity, remember this: the national accounts show real GDP slowing to growth of 0.2 per cent in the March quarter, with growth in consumer spending also slowing to 0.2 per cent.

How much slower would you like it to get?

The next weak argument for a further rate rise is: “the labour market’s still tight”. The figures for the month of June showed the rate of unemployment still stuck at a 50-year low of 3.5 per cent, with employment growing by 32,600.

But the nation’s top expert on the jobs figures is Melbourne University’s Professor Jeff Borland. He notes that, in the nine months to August last year, employment grew by an average of 55,000 a month – about double the rate pre-pandemic.

Since August, however, it’s grown by an average of 35,600 a month. Sounds like a less-tight labour market to me.

And Borland makes a further point. Whereas the employment figures measure filled jobs, the actual number of jobs can be thought of as filled jobs plus vacant jobs – which tells us how much work employers want done.

This is a better indicator of how “tight” the labour market is. And, because vacancies are falling, the growth in total jobs has slowed much faster. Since the middle of last year, part of the growth in employment has come from reducing the stock of vacancies.

Another thing the Reserve (and its money-market urgers) need to remember is that, when it comes to slowing economic activity to slow the rise in prices, interest rates (aka monetary policy) aren’t the only game in town.

Professor Ross Garnaut, also of Melbourne University, wants to remind us that “fiscal policy” (alias the budget) is doing more to help than we thought. The now-expected budget surplus of at least $20 billion means that, over the year to June 30, the federal budget pulled $20 billion more out of the economy than it put back in.

Garnaut says he likes the $20 billion surplus because, among other reasons, “we can run lower interest rates”.

One last thing the Reserve board needs to remember. Usually, when it’s jamming on the interest-rate brakes to get inflation down, the problem’s been caused by excessive growth in wages. Not this time.

Since prices took off late in 2021, wages have fallen well behind those prices. Indeed, wages haven’t got much ahead of prices for about the past decade. And while consumer prices rose by 7 per cent over the year to March, the wage price index rose by only 3.7 per cent.

This has really put the squeeze on household incomes and households’ ability to keep increasing their spending. And that’s before you get to what rising interest rates are doing.

Dear Reserve Bank board members, please remember all this tomorrow morning.

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Bullock the safe choice as RBA governor, but is that what we need?

In Treasurer Jim Chalmers’ decision to accept the internal candidate as successor to Philip Lowe as Reserve Bank governor, we see what may become the ultimate judgment about the Albanese government: it wanted change, but not radical change. Not change that rocked the boat too much. Certainly, not change that got big business offside.

The choice of deputy governor Michele Bullock to move up one chair will delight the Reserve’s higher ranks (though the put-upon lower ranks may have been hoping for a newer new broom to sweep out the old order).

As with most institutions, the Reserve’s insiders want the internally determined pecking order to be preserved. The governor persuades the Canberra politicians to appoint the next-most able person as deputy and, when the time comes, they move up, as do those in the queue behind them.

The Reserve insiders’ great fear is that the pollies will impose one of their trusties on them, or – next worse – that someone from their eternal bureaucratic rival, Treasury, will be appointed to sort them out. Either way, the pecking order is disrupted.

Over the years, the Reserve has had much success in persuading governments to let it choose its own governor. This has been the safe choice for pollies of both colours.

Only once has the internal order been disrupted in (my) living memory, which was when, in 1989, treasurer Paul Keating decided to move his Treasury secretary, Bernie Fraser, from Treasury to the Reserve.

Although I was disapproving at the time, it turned out to be a very healthy development. Fraser brought a breath of fresh air to a fusty institution. He was one of our better governors, a lot more reforming than his predecessors.

Fraser came to fear that one day he’d wake up to find himself reporting to a new Liberal treasurer, Dr John Hewson, a former economics professor, who’d immediately impose on him the latest international fashion, a central bank with operational independence from the elected government, whose decisions on monetary policy (interest rates) would be guided by an inflation target.

That never happened, of course. But Fraser decided that, if this was the way the world was turning, he’d get in first and design his own inflation target, ensuring it was a sensible one.

The Kiwis, who were the first to introduce such a target, set it at zero to 2 per cent, which became the international standard. But, with help from the Reserve’s best people, Fraser decided on something more flexible: to hold the inflation rate between 2 per cent and 3 per cent “on average” over the cycle.

So, it wasn’t just higher than the others. While they had a target with sharp corners, our “on average” would free the Reserve from having to jam on the monetary brakes every time the consumer price index popped its head above 2 per cent.

Foreign officials kept telling the Reserve it should get a proper target like the Kiwis. But in the end, it was they who had to accept their target was too inflexible.

Fraser announced the new target in 1994, by casually dropping it into a speech to business economists. It wasn’t until the next Liberal treasurer, Peter Costello, arrived in 1996, that the target, and the Reserve’s operational independence, were formalised in an agreement between Costello and the new governor, Ian Macfarlane.

Opposition leader Peter Dutton has said that neither present Treasury Secretary Dr Steven Kennedy, nor Finance Secretary Jenny Wilkinson should be appointed to succeed Lowe because they would be “tainted” by their work with the Labor government.

This was ignorant nonsense. He failed to note that both those people were equally “tainted” by their close work with that last Liberal treasurer, Josh Frydenberg, throughout the pandemic.

So it’s worth remembering that, because of Fraser’s close connection to (by then) prime minister Keating, the money market smarties were convinced Fraser wouldn’t be raising interest rates before the 1996 election.

Wrong. He did. Indeed, he raised them before a crucial byelection, which Keating lost in the run-up to losing the election. Since then, governor Glenn Stevens raised rates during the 2007 election campaign, and Lowe during the 2022 campaign.

Getting back to the point, I’d have been happy to see someone from Canberra put in to implement the (more sensible of the) reforms proposed by the recent review of the Reserve’s performance. Such an insular, self-perpetuating institution needs a regular injection of new blood.

With the benefit of hindsight, it’s almost as though Lowe’s speech last week outlining the Reserve’s plans to implement the review’s recommendations – with Bullock having done most of the work on those proposals – constituted her application for the top job.

Or maybe it was the Reserve’s written undertaking to the Treasurer that, should he agree to preserve the order of succession, it would nonetheless faithfully implement the changes needed.

That so many of those changes – which would be of little interest to any but Reserve insiders and the small army of Reserve-watching outsiders – can be described as major reform says much about what a stick-in-the-mud outfit successive governments have allowed it to become.

The number of meetings of the Reserve Bank board will be cut from 11 a year to eight. Really. Wow.

In making that change, the Reserve will continue its practice of having four of its meetings timed to come soon after publication of the quarterly CPI. But it will use the opportunity to have the remaining four meetings come soon after publication of the quarterly national accounts.

The present practice of meeting on the first Tuesday of the month meant it was meeting the day before it found out how fast the economy had been growing.

Get it? The Reserve could have fixed this problem any time in the past several decades by moving its board meetings to fit. But no, it took a full-scale independent review to make it change its practice. We like doing things the way they’ve always been done. (The good news? No more meetings on Melbourne Cup Day.)

The only significant administrative change will be to have decisions about interest rates made by a board better able to argue the toss with the governor. In particular, what they need (and is already in the pipeline) is someone with expertise in real-world wage-fixing.

The real world keeps changing under the feet of economists, and we need central bankers capable of changing their views in an economy where the cause of inflation is changing from excessive wage growth to excessive profit growth.

That requires more debate within the Reserve, and more opportunity for the newly recruited bright young economics graduates to debate matters with the old blokes at the top.

The Reserve’s problem is too much deference to the views and wishes of the governor. It’s long been a one-man band. Bullock’s appointment as the first female governor ends that problem at a stroke. Let’s hope she does better than turn it into a one-woman band.

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Business cries poor on wages, even as profits mount

Don’t believe anyone – not even a governor of the Reserve Bank – trying to tell you the Fair Work Commission’s decision to increase minimum award wages by 5.75 per cent is anything other than good news for the lowest-paid quarter of wage earners.

Because they are so low paid, and mainly part-time, these people account for only about 11 per cent of the nation’s total wage bill. So, as the commission says, the pay rise “will make only a modest contribution to total wages growth in 2023-24 and will consequently not cause or contribute to any wage-spiral”.

But that’s not the impression you’d get from all the wailing and gnashing of teeth by the main employer group, the Australian Chamber of Commerce and Industry. It claims “an arbitrary increase of this magnitude consigns Australia to high inflation, mounting interest rates and fewer jobs”.

These are the sort of dramatics we get from the Canberra-based employers’ lobby before and after every annual wage review. They lay it on so thick I doubt anyone much believes them.

But it’s worse than that. In the age-old struggle between labour and capital – wages and profits – most economists have decided long ago whose side they’re on, and long ago lost sight of how one-eyed they’ve become.

For a start, many of the talking heads you see on telly work for big businesses. They’re never going to be caught saying nice things about pay rises.

Econocrats working for conservative governments have to watch what they say. And parts of the media have business plans that say: pick a lucrative market segment, then tell ’em what they want to hear.

In my experience, there’s never any shortage of experts willing to fly to the defence of the rich and powerful, in the hope that some of the money comes their way.

But I confess to being shocked in recent times by the way the present Reserve Bank governor, Dr Philip Lowe, has been so willing to take sides. The way he preaches restraint to ordinary workers struggling to cope with the cost of living, but never urges businesses to show restraint in the enthusiasm with which they’ve been whacking up their prices.

It’s true that Lowe has a board that’s been stacked with business people, but that’s been true for all his predecessors, and they were never so openly partisan.

When businesses take advantage of the excessively strong demand that Lowe himself helped to create, that’s just business doing what comes naturally, and must never be questioned, even in an economy characterised by so much oligopoly – big companies with the power to influence the prices they charge.

But when employees unite to demand pay rises at least sufficient to cover the rising cost of living, this is quite illegitimate and to be condemned. The more so when a government agency such as the Fair Work Commission acts to protect the incomes of the poorest workers.

On Friday, the commission set out what has long been the rule for fair and efficient division of the spoils of the market system between labour and capital: “In the medium to long term, it is desirable that modern award minimum wages maintain their real value and increase in line with the trend rate of national productivity growth”.

In other words, wage rises don’t add to inflation unless their growth exceeding inflation exceeds the nationwide (not the particular business’) trend (that is, over a run of years, not just the last couple) rate of growth in the productivity of labour (production per hour worked).

But last week, in his appearance before a Senate committee, Lowe was twisting the rule to suit his case, setting nominal (before taking account of inflation) unit labour costs (labour costs adjusted for productivity improvement) not real unit labour costs as the appropriate measure.

He told the senators that growth in labour costs per unit of 3 or 4 per cent a year was adding to inflation because the past few years had seen no growth in the productivity of labour (which, of course, is the fault of the government, not the businesses doing the production).

This is dishonest. What he was implying was that wage growth should not bear any relationship to what’s happening to prices at the time. Wage growth should be capped at 2.5 per cent a year every year, come hell or high water.

Without any productivity improvement, any wage growth exceeding 2.5 per cent was inflationary. Should the nation’s businesses choose to raise their prices by more than 2.5 per cent, what was best for the economy was for the workers’ wages to fall in real terms.

Now, Lowe is a very smart man, and I’m sure he doesn’t actually believe anything so silly. Like the employer groups, he’s cooked up a convenient argument to help him achieve his KPIs. He sees the inflation rate as his key performance indicator.

He’s got to get it down to the 2 to 3 per cent target range, and get it down quick. He ain’t too worried what shortcuts he takes or who gets hurt in the process.

When he claims that, absent productivity improvement, wage rises far lower than the rate of inflation are themselves inflationary, what he really means is that they make it harder for him to achieve his KPIs.

Clearly, the wage rise that would help him get the inflation rate down fastest is a wage rise of zero. It would plunge the economy into recession, and businesses would have a lot more trouble finding customers, but who cares about that?

It’s not true that sub-inflation-rate pay rises add to inflation. What is true is that the bigger the sub-inflation rise, the longer it takes to get inflation down. But he doesn’t like to say that.

Why’s he in such a hurry he’s happy for ordinary workers to suffer? Because he lies awake at night worrying that, if it takes too long to get inflation down, inflation expectations will rise and a price-wage spiral will become entrenched.

Does Treasury secretary Dr Steven Kennedy also lie awake? Doesn’t seem to. He told the senators last week that “there are no signs of a wage-price spiral developing and medium-term inflation expectations remain well anchored”.

If ever there was a general fighting the last war, it’s Lowe.

Meanwhile, please don’t say business profits seem to be going fine. It may be true, but please don’t say it. Business doesn’t like you saying such offensive things, and business’ media cheer squad goes ape.

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Our big risk: fix inflation, but kiss goodbye to full employment

If you think getting inflation down is our one big economic worry, you have a cockeyed view of economic success. Unless we can get it under control without returning to the 5 to 6 per cent unemployment rate we lived with in recent decades, we’ll have lost our one great gain from the travails of pandemic: our return to full employment.

And if we do lose it, it will demonstrate the great price Australia paid for its decision in the 1980s to join the international fashion and hand the management of its economy over to the central bankers.

There has always been a tricky trade-off between the twin objectives of low inflation and low unemployment. If our return to full employment proves transitory, it will show what we should have known: that handing the economy over to the central bankers and their urgers in the financial markets was asking for inflation to be given priority at the expense of unemployment.

In his customary post-budget speech to economists last Thursday, Treasury secretary Dr Steven Kennedy began by explaining to academic economists why their claim that the budget was inflationary lacked understanding of the intricacies of economics in the real world.

But his strongest message was to remind economists why full employment is a prize not to be lost.

Whereas early in the pandemic it was feared the rate of unemployment would shoot up to 15 per cent and be difficult to get back down, the massive fiscal (budgetary) stimulus let loose saw it rise only to half that, and the remarkable economic rebound saw it fall to its lowest level in almost 50 years.

“This experience is altering our views on full employment,” Kennedy says. “One of the stories of this budget – one that risks being lost – is the virtue of full employment.”

For one thing, near-record low unemployment and a near-record rate of participation in the labour force are adding to demand and to our capacity to supply goods and services.

This time last year, Treasury was expecting a budget deficit of $78 billion in the financial year ending next month. Now it’s expecting a surplus of $4 billion. Various factors explain that improvement, but the greatest is the continuing strength of the labour market.

As I explained last week, this revision has significantly reduced the projected further increase in the public debt and, in consequence, our projected annual interest bill on the debt every year forever. It has thereby significantly reduced our projected "structural" budget deficit although, Kennedy insists, has not eliminated it.

And getting a higher proportion of the working-age population into jobs – and having more of the jobs full-time – improves our prospects for economic growth and prosperity.

There’s no source of economic inefficiency greater than having many people who want to work sitting around doing nothing. And adding to the supply of labour is not, of itself, inflationary.

But let’s not confuse means with ends. The most important benefit of full employment goes not to the budget or even The Economy, but to those people who find the jobs, or increased hours of work, they’ve long been seeking.

Kennedy reminds us that the greatest benefit goes to those who find it hardest to get jobs. While the nationwide unemployment rate has fallen by 1.6 percentage point since before the pandemic, it has fallen by 3.2 percentage points for youth, and by 2.3 percentage points for those with no post-school education.

This is where we get to Kennedy’s observation that recent experience is altering Treasury’s views on full employment.

The obvious question this experience raises is: why have we been willing to settle for unemployment rates of 5 to 6 per cent for so long when, as he acknowledges, “the low rate of unemployment and high levels of participation [in the labour force] have been sustained without generating significant wage pressures”?

Short answer: because economists have allowed themselves to be bamboozled by modelling results. Specifically, by their calculations of the “non-accelerating-inflation rate of unemployment” – the NAIRU.

As Kennedy says, the unemployment rate consistent with both full employment and low and stable inflation isn’t something that can be seen and directly measured. So, as with so many other economic concepts, economists run decades of inflation and unemployment data through a mathematical model which estimates a figure.

Economists have redefined full employment to be the 5 or 6 per cent unemployment rate their models of the NAIRU spit out. They think using such modelling results makes decisions about interest rates more rigorous.

But that’s not true if you let using a model tempt you to turn off your brain and stop thinking about whether the many assumptions the model relies on are realistic, and whether more recent changes in the structure of the economy make results based on averaging the past 30 years misleading.

It’s now pretty clear that, at least in recent years, NAIRU models have been setting the rate too high, thus leading the managers of the economy to accept higher unemployment than they should have.

There are at least three things likely to make those modelling results questionable. One is that, as a Reserve Bank official has revealed, the models assume inflation is caused by excessive demand, whereas much of the latest inflation surge has been caused by disruptions to supply.

Professor Jeff Borland, of Melbourne University, points out that the increasing prevalence of under-employment in recent decades makes the models’ focus on unemployment potentially misleading, as does the increasing rate of participation in the labour force.

Third, unduly low unemployment and job shortages are supposed to lead, in the first instance, to wage inflation, not price inflation. But this turns to a great extent on the bargaining power of unionised labour, which many structural factors – globalisation, technological advance, labour market deregulation and the decline in union membership – have weakened.

If the NAIRU models adequately reflect these structural shifts I’d be amazed.

What is clear is that the Reserve Bank’s understanding of contemporary wage-fixing is abysmal. As yet, it has no one on its board with wage-fixing expertise, its extensive consultations with business leaders exclude union leaders, and Reserve Bank governor Dr Philip Lowe says little or nothing about wage-fixing arrangements.

And this is despite Lowe’s unceasing worry about the risk of a price-wage spiral and an upward shift in inflation expectations. So far, there’s little evidence of either.

Some increase in unemployment is inevitable as we use the squeeze on households’ disposable income to slow demand and thus the rate at which prices are rising.

But if the Reserve’s undue anxiety about wages and expectations leads it to hit the brakes so hard we drop into recession, and full employment disappears over the horizon, it will be because we handed our economy over to the institution least likely to worry about making sure everyone who wants to work gets a job.

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How party politicking let mining companies wreck our economy

A speech by former Treasury secretary Dr Ken Henry last month was reported as a great call for comprehensive tax reform. But it was also something much more disturbing: an entirely different perspective on why our economy has been weak for most of this century and – once the present pandemic-related surge has passed – is likely to stay weak.

The nation’s economists have been arguing for years about why the economy has grown so slowly, why real wages have been stagnant for at least a decade, why the rate of productivity improvement is so low and why business investment spending has been so little for so long.

Most economists think we’ve just been caught up in the “secular stagnation” – or slow-growth trap – that all the advanced economies are enduring.

But Henry has a very different answer, one that’s peculiar to Australia. Unlike everyone else, he’s viewing our economy from a different perspective, the viewpoint of our “external sector” – our economic dealings with the rest of the world.

What conclusion does he come to? We’ve allowed ourselves to catch a bad case of what economists call “Dutch disease” – but Henry thinks should be renamed Old and New Holland disease.

When a country discovers huge reserves of oil or gas off its coast – or, in our case, the industrialisation of China causes the prices of coal and iron ore to skyrocket – all the locals think they’ve won the lottery and all the other countries are envious. Now we’ll be on easy street.

But when the Dutch had such an experience in the 1960s, they eventually discovered that, while it was great for their mining industry, it was hell for all their other trade-exposed industries.

Why? Because the inflow of foreign financial capital to build the new industry and the outflow of hugely valuable commodity exports send the exchange rate sky-high, which wrecks the international price competitiveness of all your other export and import-competing industries: manufacturing, farming and services.

Not only that. The rapidly expanding mining industry attracts labour and capital away from the other industries, bidding up their costs. Their sales are down, but their costs are up. You’re left with a “two-speed economy”. Remember that phrase? It’s what we’ve had for a decade or two.

Well, interesting theory, but where’s Henry’s evidence that Dutch disease is at the heart of our problems over recent decades?

He’s got heaps. Start with the way the composition of our exports has changed. Between 2005 and today, and in round figures, mining’s share of our total exports has doubled from 30 per cent to 60 per cent. Manufacturing’s share has fallen from 40 per cent to 20 per cent. Everything else – mainly agriculture and services – has fallen from 30 per cent to 20 per cent.

Over the same period, exports grew from 20 per cent of gross domestic product to 27 per cent. This means mining exports’ share of GDP has gone from about 6 per cent to more than 16 per cent. Manufacturing exports’ share has fallen from about 8 per cent to 5.5 per cent.

Next, who buys our exports? China’s share has gone from about 10 per cent to more than 45 per cent. Actually, that was the peak it reached before China’s imposition of restrictions after some smart pollie decided it would be a great idea for Australia to lead the charge of countries blaming China for COVID. Since then, China’s share has fallen to 30 per cent.

Since 2005, mining’s share of total company profits has gone from about 20 per cent to 50 per cent. Manufacturing’s share has fallen from about 20 per cent to less than 10 per cent. Financial services – banking and insurance – have seen their share fall from 20 per cent to less than 5 per cent.

Now, what’s happened to those industries’ share of total employment? Manufacturing’s share has fallen from more than 9 per cent to about 6 per cent. Financial services’ share has been steady at a bit over 3 per cent. Mining’s share has risen from less than 1 per cent to 1.5 per cent. You beauty.

“In summary,” Henry says, “mining employs a very small proportion of the Australian workforce – except in the boom times, when it induces a worker to leave other jobs for mine-site construction work – generates about 60 per cent of Australia’s exports, about half of pre-tax profits (mostly repatriated overseas to foreign shareholders) and exposes the Australian economy to highly volatile global commodity prices and a heavy strategic dependence upon a single buyer, China.”

Not to mention the way mining leaves us heavily exposed to “the risk of global decarbonisation”.

How have we profited from being a mining-dominated economy? Real GDP per person – a rough measure of our material standard of living – has been in trend decline for two decades. In the decade pre-pandemic, “we recorded the sort of growth rates only previously recorded in recessions,” Henry says.

This weakness is largely explained by our poor productivity performance. Though no one else seems to have noticed, our productivity growth is negatively correlated with our “terms of trade” – the prices we get for our exports, relative to the prices we pay for our imports.

That is, when our terms of trade improve, our rate of productivity improvement worsens. And our terms of trade are largely driven by world commodity prices, especially for coal, gas and iron ore.

Now the tricky bit. Why would a mining boom depress productivity improvement? Because of the way it raises our real exchange rate – our nominal exchange rate, adjusted for the change in our rate of production-cost inflation relative to those of our trading partners.

The resources boom increased our nominal exchange rate by about 25 per cent. Then, by 2011, high wages growth and weak productivity growth relative to our trading partners had added a further 35 per cent to the rise in the real exchange rate, Henry calculates.

This caused our non-mining producers to suffer a “profound loss of international competitiveness”. Is it any wonder that, between the turn of the century and 2019, the annual rate of investment by non-mining businesses fell from 7 per cent of GDP to 5 per cent?

The result is that two centuries of “capital-deepening” – increased equipment per worker – have stalled. This move to “capital-shallowing” explains our poor productivity.

And also, our move from current account deficit to current account surplus. “We are exporting [financial] capital because Australia has become an increasingly unattractive destination for doing business in the eyes of foreign investors and Australian [superannuation] savers alike,” Henry says.

“The mining boom has left us with a very big competitiveness overhang that will probably take decades to work off,” he says, including by decades of weak growth in real wages.

What should we have done differently? Had we applied a rational tax to the windfall profits of the mining companies, we would not only have retained for ourselves more of the proceeds from the export of our own natural resources, but also caused the rise in our real exchange rate to be lower.

Remember Kevin Rudd’s proposed “resource super profits tax”? The mining lobby set out to stop it happening, telling a pack of lies about how it would wreck the economy. The Abbott-led opposition threw its weight behind the mainly foreign miners.

Julia Gillard consulted the industry and cut the tax back to nothing much. The incoming Abbott government abolished it.

Petty, short-sighted politicking caused us to sabotage our economy for decades to come.

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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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Most of us don't really want to be rich, for better or worse

When it comes to economics, the central question to ask yourself is this: do you sincerely want to be rich? Those with long memories – or Google – know this was the come-on used by the notorious American promoter of pyramid schemes, Bernie Cornfeld. But that doesn’t stop it being the right question.

It’s actually a trick question. Most of us would like to be rich if the riches were delivered to us on a plate. If we won the lottery, or were left a fortune by a rich ancestor we didn’t know we had.

But that’s not the question. It’s do you sincerely want to be rich. It ain’t easy to become rich by your own efforts, so are you prepared to pay the price it would take? Work night and day, ignore your family and friends, spend very little of what you earn, so it can be re-invested? Come unstuck a few times until you make it big? Put it that way and most of us don’t sincerely want to be rich. We’re not that self-disciplined and/or greedy.

The question arises because the Productivity Commission’s five-yearly report on our productivity performance has found that, as a nation, we haven’t got much richer over the past decade – where rich means our production and consumption of goods and services.

When business people, politicians and economists bang on about increasing the economy’s growth, they’re mainly talking about improving the productivity – productiveness – of our paid labour.

The economy – alias gross domestic product – grows because we’ve produced more goods and services than last year. Scientists think this happens because we’ve ripped more resources out of the ground and damaged the environment in the process.

There is some of that (and it has to stop), but what scientists can never get is that the main reason our production grows over the years is that we find ways to get more production from the average hour of work.

We do this by increasing the education and training of our workers, giving them better machines to work with, and improving the way our businesses organise their work.

But the commission finds that our rate of productivity improvement over the past decade has been the slowest in 60 years. It projects that, if it stays this far below our 60-year average, our future incomes will be 40 per cent below what they could have been, and the working week will be 5 per cent longer.

It provides 1000 pages of suggestions on how state and federal governments can make often-controversial changes that would lift our game and make our incomes grow more strongly.

So, this is the nation’s do-you-sincerely-want-to-be-rich moment. And my guess is our collective answer will be yeah, nah. Why? For good reasons and bad. Let’s start with the negative.

If you think of the nation’s income as a pie, there are two ways for an individual to get more to eat. One is to battle everyone else for a bigger slice. The other is to co-operate with everyone to effect changes that would make the pie – and each slice - bigger.

For the past 40 years of “neoliberalism”, which has focused on the individual and sanctified selfishness, we’ve preferred to battle rather than co-operate.

Our top executives have increased their own remuneration by keeping the lid on their fellow employees’ wages. Governments have set a bad example by imposing unreasonably low wage caps.

Then they wonder why their union won’t co-operate with their efforts to improve how the outfit’s run. Workers fear there’ll be nothing in it for them.

It’s the same with politics. Governments won’t make controversial changes because they know the opposition will take advantage and run a scare campaign.

But there are also good reasons why we’re unlikely to jump to action in response to the commission’s warning. The first is that economists focus on the material dimension of our lives: our ability to consume ever more goods and services.

We’re already rich – why do we need to be even richer? There’s more to life than money, and if we gave getting richer top priority, there’s a big risk those other dimensions would suffer.

Would a faster growing economy tempt us to spend less time enjoying our personal relationships? How would that leave us better off overall (to coin a phrase)?

How much do we know about whether the pace of economic life is adding to stress, anxiety and even worse mental troubles?

If we did go along with the changes the commission proposes, what guarantee is there that most of the increased income wouldn’t go to the bosses (and those terrible people with more than $3 million in superannuation)?

What we do know is that we should be giving top priority to reducing the damage economic activity is doing to the natural environment, including changing the climate. If that costs us a bit in income or productivity, it’s a price worth paying.

And there are various ways we could improve our lives even if our income stopped growing. Inquire into them.

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Ever wondered why your wages aren't rising?

It’s dawning on people that when the competition between businesses isn’t strong, firms can raise their prices by more than the increase in their costs, and so fatten their profit margins. What’s yet to dawn is that weak competition also allows businesses to pay their workers less than they should.

In standard economic theory, it’s the intense competition between firms that prevents them from overcharging for their products and earning more than a “normal” profit.

Normal profit gives the owners of the firm just sufficient return on the capital they’ve invested to stop them leaving the industry and trying their luck elsewhere.

The theory assumes the industry has numerous firms, each one too small to influence the market price. In today’s world, however, many markets are dominated by just two, three or four huge firms.

These firms are big enough to influence the market price, especially when it’s so easy for them to collude tacitly with their rivals.

We see the four big banks doing this every time interest rates are raised. They have an unspoken agreement not to compete on price.

EverI say they have “pricing power”, but many economists say they have “monopoly power”. How can a handful of firms have monopoly power? Because economists don’t use that term literally. On a scale of one to 1000 firms, we’re right down the monopoly end.

Dr Andrew Leigh, the Assistant Minister for Competition, and a former economics professor, has been giving a series of speeches about recent empirical studies on how competitive our markets are.

In one, he quoted the findings of Jonathan Hambur, a researcher who pivots between Treasury and the Reserve Bank, that Australian firms’ “mark-ups” – the gap between their cost of production and their selling price – have been rising steadily.

But in a further speech this month, Leigh turned the focus from what “market concentration” (among a few massive companies) means for the industry’s customers, to what it means for its employees.

So, in econospeak, we’re moving from monopoly to “monopsony”. Huh? Taken literally, monopoly means a market in which there’s a single seller meeting the demand for the product. Monopsony means there’s a single buyer from the people supplying the inputs to production. Workers supply the firm with the labour it needs.

The term was introduced by Joan Robinson, a colleague of Keynes at Cambridge, who was among the first to question the standard theory of how markets work. She was 30 in 1933 when she published her dissenting view that truly competitive markets were rare.

She argued that monopsony was endemic in the labour market and employers were using it to keep wages low. If there are few employers competing for workers, those workers have fewer “outside options” (to move to another firm offering higher pay or better conditions).

This limits workers’ bargaining power and gives employers the power to keep wages lower.

At the time, few economists took much interest. But in recent years there’s been a growing focus on market power by academic economists.

For instance, monopsony was cited in a US Supreme Court ruling against Apple in 2019. A report by Democrats in the US House of Representatives accused Amazon of using monopsony power in its warehouses to depress wages in local markets.

Evidence from the US, Britain and Europe has demonstrated that increases in labour market concentration – fewer employers to work for – are associated with lower wages.

Leigh says economists have long known that people in cities tend to earn more than those in regional areas. His own research found that when someone moves from a rural area to a major Australian city, their annual income rises by 8 per cent.

“The economics of monopsony suggests that an important part of the urban wage premium can be explained by greater employer competition in denser labour markets,” Leigh says.

Leigh reminds us that Australia’s average full-time wage ($1808 a week last November) was only $18 a week higher than it was 10 years ago, after allowing for inflation. Many things would explain this pathetic improvement, but one factor could be employers’ monopsony.

We know that the rate at which people move between employers has fallen. But over a person’s working life, the biggest average wage gains come when people switch employers. And when some people leave, the bargaining power of those who stay is increased.

This decline in people moving could be caused by increased employer monopsony. Hambur has done a study of employment concentration between 2005 and 2016.

He found that, within industries where concentration rose, growth in real wages over the decade was significantly lower.

When a firm has a large share of the industry’s employment, the gap between the value of the work a worker does, and the wage they’re paid in return, tends to grow.

He found that employment in regions close to major cities is twice as concentrated as in the cities. In remote areas it’s three times.

Read this carefully: Hambur found that labour markets had not become more concentrated over the decade. But at every degree of concentration, its negative impact on wages had more than doubled.

So, employers’ market power could well be a factor helping to explain the virtual absence of real wage growth over a decade. Hambur finds that the greater impact of employer concentration may have caused wage growth between 2011 and 2015 to be 1 per cent lower than otherwise.

This would help explain why not all the (weak) growth in the productivity of labour during the period was passed through to real wages – as conventional economists and business people always assure us it will be. Weak competition allowed employers to keep a lot of it back for themselves.

Part of the competitive process is new firms entering the industry. New firms usually poach staff away from the existing firms. But we know the rate of new entry has declined.

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Can the critics prove higher profit margins are fuelling inflation?

There’s a big risk we’ll fail to learn a vital lesson from our worst inflation outbreak in decades. If inflation is such a scourge that we must pay a terrible price to get it back under control, why do we do so little to stop big companies from acquiring the power to raise their prices by more than needed to cover their rising costs?

Economists are far more comfortable thinking about inflation at the top, macro level than the bottom, micro level. At the top, inflation is caused by aggregate (total) demand for goods and services growing faster that aggregate supply – the economy’s ability to produce those goods and services.

We know from Reserve Bank figuring that more than half the price rise we’ve seen has come from temporary disruptions to the supply of production inputs, caused by the pandemic and the Ukraine war.

But, the Reserve insists, prices have also risen because demand’s been stronger than it should have been. Why? Because in our efforts to hold the economy together during the pandemic, we applied far more economic stimulus than was needed.

Economists – even those who stuffed up the stimulus – are comfortable with this explanation because it puts the blame on government. The model of the economy they carry in their heads tells them the market usually works fine, whereas it’s government intervention in the market that usually causes the problems.

So, you can see why economists were so discombobulated when one of the world’s top macroeconomists, Olivier Blanchard, tweeted about “a point which is often lost in discussions of inflation”. “Inflation,” he wrote, “is fundamentally the outcome of the distributional conflict between firms, workers and taxpayers.”

He’s saying economists need to look at the more fundamental, bottom-up factors driving inflation. Is worsening inflation caused by workers and their unions successfully demanding real wage rises higher than the increasing productivity of their labour justifies?

Or is the strength of competition insufficient to do what the mental model promises: prevent firms from raising their prices beyond what’s needed to cover their higher costs (including a “normal” return – profit – on the capital invested by their owners)?

The strange fact is that economists and econocrats have a long history of lecturing workers and unions on the need for wage restraint. Reserve Bank governor Dr Philip Lowe has been saying workers must be “flexible” and accept wage rises far less than the rise in consumer prices. That is, take a big pay cut in real terms.

But economists are infinitely more reticent in urging businesses to go easy with their price rises. I suspect this is partly because of the biases hidden in their mental model, but mainly because they know their employer, or the big-business lobby, or its media cheer squad, or all the business people on the Reserve’s board, would tear into them for daring to say such a thing.

Similarly, economists have insisted the Australian Bureau of Statistics publish any number of different measures of wage growth, but few measures of profit growth.

Last month, Dr Jim Stanford, of the Australia Institute, sought to even things up a bit by publishing figures that broke the inflation rate up into the bit caused by rising wages and the bit caused by rising profits.

He found that “excess corporate profits account for 69 per cent of additional inflation beyond the Reserve Bank’s target”, whereas rising labour costs per unit of production (that is, after adjusting for the productivity of labour) account for just 18 per cent.

What? Huh? Never seen an exercise like that before. How’d he cook that up? The business lobby went on the attack and the business press consulted a few economists who lazily dismissed it as nonsense.

But though it’s unfamiliar, it’s not as weird as you may think. Stanford was copying the method used by some crowd called the European Central Bank. What would they know?

Well, OK. But how can you take the rise in the prices of products over a period and “decompose” it (break it down) into the bit caused by rising wage costs and the bit caused by rising profits?

By taking advantage of the fact that, every time we measure the growth in gross domestic product in the “national accounts”, we measure it three different ways.

First, the growth in the nation’s expenditure on goods and services. Second, the growth in the nation’s income from wages, profits and other odds and sods. Third, the growth in the production of goods or services by each of our 19 different private and public sector industries.

In principle, each way you measure it gives you the same figure for GDP. Then you use a “deflator” to divide the growth in nominal GDP between the bit caused by higher prices and the bit caused by higher quantities – the “real” bit.

So, it’s quite legitimate to take this measure of inflation and break it up between higher wages and higher profits (leaving the bit caused by changes in taxes and subsidies).

Actually, the stats bureau’s been doing this exercise for wages (“nominal unit labour costs”) for decades, but not doing it for profits (because no one’s been keen to know the results).

Note that the “GDP deflator” is a quite different measure of inflation to the one we usually focus on: the index of consumer prices.

Note, too, that the Ukraine war has caused a huge jump in the profits of our energy producers. This windfall hasn’t been caused by businesses sneaking up their profit margins (“mark-ups”, as economists say). But the growth in mining industry profits accounts for only about half the rise in total profits over the three years to December 2022.

I’m not comfortable relying on a think tank for these figures. But if the economists who champion big business don’t like it, they should take this exercise seriously and join the debate. The government should ask the stats bureau to finish doing the numbers itself.

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