Today, Fair Work Australia, the new body that the incoming Labor government set up to replace the Fair Pay Commission, which the conservatives had crafted to cut real wages, released its first decision. The Minimum Wage Panel of FWA released its first Annual Wage Review under the Fair Work Act 2009 (Fair Work Act) and awarded minimum wage workers an additional $26 per week which amounted to a 4.8 per cent rise. With inflation running around 2.9, the decision provides for a real wage increase barely in line with productivity growth. The decision will apply over from July 1, 2010 to June 30, 2011. The decision does little to restore the real wage losses that low-paid workers have endured over the decade is it sufficient to restore the deterioration of low-pay outcomes relative to average earnings in the economy.
In the Full Decision handed down today, the Fair Work Australia panel said:
Official forecasts indicate that the Australian economy will continue to recover strongly from the GFC-related slowdown in 2009 over the remainder of 2010, and into 2010-11 and 2011-12. Both Treasury and the RBA expect real non-farm GDP to resume growth at levels approaching 4 per cent in 2010-11 and 2011-12, from a level of 2-2½ per cent in 2009-10, with growth driven by private sector consumption and investment and supported by a favourable terms of trade, particularly in 2010-11. The strong growth in output is expected to be reflected in the labour market, with employment growth at or in excess of 2 per cent per annum, average hours returning to more normal levels, increasing participation rates and a reduction in unemployment, notwithstanding an expansion in the labour force … Overall, Australia’s immediate economic outlook is positive, with official forecasts suggesting a resumption of strong growth in economic activity and further steady inroads into unemployment in the context of relatively stable aggregate wages and prices growth.
These are optimistic forecasts and are derived from the Treasury and RBA estimates at present. At present, the economy would have to really accelerate from its current stagnant growth rate to get near these forecasts. Please see my blog – Australia GDP growth flat-lining – where I consider the first quarter National Accounts results, published yesterday for more on the likely outcomes in the period ahead.
It is also interesting that the employers in recent months have been screaming for renewed targetted immigration to address the so-called skills shortage that they claim exists but in this wage hearing they are claiming the economy is not strong enough to pay a 4.8 per cent rise in the wages to the lowest paid workers.
In the Fair Work Australia conclusion their view on this issue is expressed as:
Our view is that the low paid need the highest level of wages that is consistent with all other objectives including low unemployment, low inflation and the viability of business enterprises. At the least, this level of wages should enable a full-time wage earner to attain a standard of living that exceeds contemporary indices of poverty. We are open to evidence that there are particular economic developments that are placing unusual and severe strain on the budgets of the low paid.
While this is a considerable change in emphasis from the previous minimum wage tribunal set up by the last conservative government as an explicit real wage cutting mechanism, the FWA vision falls short of what I find acceptable.
I would not set the minimum wage on capacity to pay grounds. So whether the forecasts are overly optimistic is irrelevant in my view. I would ignore cyclical patterns when considering what the level of the minimum wage should be.
The minimum wage is a statement of how sophisticated you consider your nation to be. Minimum wages define the lowest standard of wage income that you want to tolerate. In any country it should be the lowest wage you consider acceptable for business to operate at. Capacity to pay considerations then have to be conditioned by these social objectives.
If small businesses or any businesses for that matter consider they do not have the “capacity to pay” that wage, then a sophisticated society will say that these businesses are not suitable to operate in their economy. Firms would have to restructure by investment to raise their productivity levels sufficient to have the capacity to pay or disappear. The outcome is that the economy pushes productivity growth up and increases standards of living.
No worker should be paid below what is considered the lowest tolerable standard of living just because low wage-low productivity operator wants to produce in a country.
If you examine the decision you can see what the various submitting parties representing labour and capital requested. The largest demand was from the Women’s Electoral Lobby (WEL) and National Pay Equity Coalition (NPEC) which jointly recommended that the NMW and increase of $49.00 or 9 per cent. As the Fair Work Australia decision says “(t)his would set the weekly rate at $592, a figure relative to average weekly earnings of 48.5 per cent – just short of the pre-AFPC era.”
The Australian Council of Trade Unions (ACTU) want a rise of $27.00 a week and so will be happy with today’s decision. The main small-medium employers’ federations wanted a rise constrained to $12.62 per week which was consistent with the $12 per week demand from the large employers group. Then you had a ragbag of employers groupings (farmers, retailers. housing industry) all requesting very small rises.
The following graph shows the ratio of the Federal minimum wage to the Full Time Adult Ordinary time earnings series provided by the ABS (since the third quarter 1994 until the end of 2010). The last three quarters in 2010 are simulated based upon a constant growth in earnings. The new FMW applies from July 1, 2010 so will be constant over the last 2 quarters of 2010.
The logic of the neo-liberal period which encompasses the data sample shown (and then some) was to cut at the bottom of the labour market. Today’s decision continues that trend and forces workers at the bottom of the wage distribution to fall further behind in relative terms.
Staggered wage decisions and real wages
There are also problems with just “maintaining real FMWs” if there are long gaps between adjustments. With inflation going on continuously (more or less), the annual adjustments by the AFPC hand employers huge gains and deprive the workers of real income. The following discussion and diagram explain why.
Assume that at the time of policy implementation, the real FMW wage was wi and there was no inflation. The wage setting authority (in this case the AFPC) manipulates a nominal minimum wage (the $ weekly value) and the real wage equivalent of this nominal wage is found by dividing the nominal wage by the inflation rate. Assume that inflation assumes a positive constant rate at Point 0 onwards.
The nominal wage is the $-value of your weekly wage whereas the real wage equivalent is the quantity of real goods and services that you can purchase with that nominal wage. For a given nominal wage, if prices rise then the real wage equivalent falls because goods and services are becoming more expensive.
The following diagram depicts the real income losses that arise when indexation is not continuous, that is, when the AFPC makes, say, an annual adjustment in the FMW (you may want to click it to get it in a new window so you can print it while you follow the description):
Over the period O-D1 the inflation rate continuously erodes the real value of the nominal wage and immediately before the next indexation decision, the real wage equivalent of the fixed nominal FMW is w2. The real income loss is computed as the area A, which is half the distance (0-D1) times distance (w1-w2).
At point D1 the wage setting authority increases the nominal wage to match the current inflation rate which restores the real wage to w1, but the workers do not recoup the deadweight real income losses equivalent to area A.
The same process occurs in the period between the D1 and the next decision D2, resulting in further real income losses equivalent to area B. These losses are cumulative and are greater: (a) the higher is the inflation rate; (b) the longer is the period between decisions; and (c) the higher is the real interest rate (reflecting the opportunity cost over time).
Clearly, the patterns of real income loss are different if the wage setting authority adopts a decision rule other than full indexation (that is, real wage maintenance). For example, say it decides not to adjust nominal wages fully at the time of its decision (or in fact at the implementation date of its decision) to the current inflation rate then the real income losses increase, other things equal.
So at time D1 the authority decides to discount the real wage (less than full indexation) and increases the nominal wage rate such that the real wage at that point is equal to w3.
Over the next period to D3, the real wage falls to w4 and at the time of the next decision (implementation time D3) the real income losses would be equal to the triangle D (reflecting the inflation effect over the period D2- D3, plus the rectangle C, which reflects the losses arising from the decision to partially index at D2.
Similarly, one can imagine that the adjustment at a particular time might involve a real wage increase (more than full compensation for the current inflation rate) which would then partially offset some of the real income loss borne in the previous period when nominal wages were unadjusted but inflation was positive.
So if you understand the saw tooth pattern of indexation shown here you will see that the triangles A and B represent real losses for the workers between wage setting points even if real wage maintenance is the preferred policy. These losses are worse (areas C and D) if there is only partial adjustment. These losses occur because inflation is a more continuous process than the adjustments in FMW and accrue to the employer. The employers are pocketing these wage losses every day because their revenue is geared to the price rises and they are paying constant nominal wages to the workers.
The following graph shows the evolution of the real Federal Minimum Wage since July 2005 extrapolated out to the end of 2010 based on a constant inflation rate. You can see the saw-tooth pattern that the theoretical discussion above describes. Each period that curve is heading downwards the real value of the FMW is being eroded. Each of the peaks represents a formal wage decision by the wage setting tribunal (now Fair Work Australia).
When the workers get the pay rise on July 1, 2010 their real wage equivalent of the nominal FMW will be around what it was five years ago. However, in the meantime, between the wage determination decisions, their purchasing power has been cut significantly – these are permanent losses.
The next graph shows the erosion of the real wage more clearly. The red line is the inflation index and the blue line the nominal Federal Minimum Wage index (June 2005=100).
Minimum wages and employment
Many academic studies have sought to establish the empirical veracity of the neoclassical relationship between unemployment and real wages and to evaluate the effectiveness of active labour market program spending. This has been a particularly European and English obsession. There has been a bevy of research material coming out of the OECD itself, the European Central Bank, various national agencies such as the Centraal Planning Bureau in the Netherlands, in addition to academic studies. The overwhelming conclusion to be drawn from this literature is that there is no conclusion. These various econometric studies, which have constructed their analyses in ways that are most favourable to finding the null that the orthodox line of reasoning (that wage rises destroy jobs) is valid, provide no consensus view as Baker et al (2004) show convincingly.
In the last 10 years, partly in response to the reality that active labour market policies have not solved unemployment and have instead created problems of poverty and urban inequality, some notable shifts in perspectives are evident among those who had wholly supported (and motivated) the orthodox approach which was exemplified in the 1994 OECD Jobs Study.
In the face of the mounting criticism and empirical argument, the OECD began to back away from its hardline Jobs Study position. In the 2004 Employment Outlook, OECD (2004: 81, 165) admitted that “the evidence of the role played by employment protection legislation on aggregate employment and unemployment remains mixed” and that the evidence supporting their Jobs Study view that high real wages cause unemployment “is somewhat fragile.”
The winds of change strengthened in the recent OECD Employment Outlook entitled Boosting Jobs and Incomes, which is based on a comprehensive econometric analysis of employment outcomes across 20 OECD countries between 1983 and 2003. The sample includes those who have adopted the Jobs Study as a policy template and those who have resisted labour market deregulation. The report provides an assessment of the Jobs Study strategy to date and reveals significant shifts in the OECD position. OECD (2006) finds that:
- There is no significant correlation between unemployment and employment protection legislation;
- The level of the minimum wage has no significant direct impact on unemployment; and
- Highly centralised wage bargaining significantly reduces unemployment.
This latest statement from the OECD confounds those who have relied on its previous work including the Jobs Study, to push through harsh labour market reforms (such as the widespread deregulation in Australia as a consequence of the WorkChoices legislation), retrenched welfare entitlements and attacked the power bases on trade unions. It makes a mockery of the arguments that minimum wage increases will undermine the employment prospects of the least skilled workers.
In their decision today, Fair Work Australia said:
In relation to the relationship between minimum wage rises and employment levels … Although a matter of continuing controversy, many academic studies found that increases in minimum wages have a negative relationship with employment, but there is no consensus about the strength of the relationship. Strong employment growth over the past decade in Australia, in the context of annual increases in minimum wages (other than in 2009) suggests that any impact of moderate minimum wage increases on employment levels is swamped by other factors affecting the demand for labour. We judge that in current economic circumstances, the increase in minimum wages we have decided on will not threaten employment growth.
To get some idea of what the data looks like I created a scatter plot of the real federal minimum wage (indexed to 100 at September 1996) (horizontal axis) and the Employment of labourers (vertical axis). The red line is a simple regression which looks pretty flat to me (indicating no relationship). If there is any relationship it is positive which means the higher the minimum wage index the higher is the labourers’ employment index. But when you run the regression in change form (don’t worry about what this means if you don’t know) one concludes there is no relationship.
In a job-rationed economy, supply-side characteristics will always serve to shuffle the queue. Internationally, there is a growing sentiment that paid employment measures must be a part of the employment policy mix.
The lack of consideration given to job creation strategies in the unemployment debate stands as a major oversight. There is growing recognition that programs to promote employability cannot, alone, restore full employment and that the national business cycle is the key determinant of regional employment outcomes. In my 2008 book with Joan Muysken – Full Employment abandoned we consider the evidence in considerable detail.
There is also an interesting study from Stephen Machin entitled – Setting minimum wages in the UK: an example of evidence-based policy, which was presented to the Fair Pay Commission’s swansong research forum in Melbourne in 2008.
Stephen Machin is Professor of Economics at University College London, Director of the Centre for the Economics of Education and a Programme Director (of the Skills and Education research programme) at the Centre for Economic Performance at the London School of Economics, an editor of the Economic Journal (one of the top academic journals), has been a visiting Professor at Harvard University and at MIT. So in mainstream terms he is thoroughly one of the orthodox club.
He examined the impact of the creation of the UK Low Pay Commission, which the Blair Labour Government established to try to remedy some of the worst excesses that the neo-liberal era had delivered to low wage workers. Both sides of politics in the UK from Thatcher onwards were remiss in this regard.
The UK Low Pay Commission (LPC) was established in 1997 and was given the task to define an effective National Minimum Wage (NMW). The following graph is taken from his Figure 1 (page 15) and is self explanatory.
Machin’s commentary is as follows:
The NMW was introduced in April 1999 at an hourly rate of £3.60 for those people over 21 years of age, with a development rate of £3.00 for those aged 18 to 21 years. The key economic question has been the impact of minimum wages on employment … Over the period 1999 to 2007, the macroeconomic picture indicates that employment continued to grow as minimum wages rose (Figure 1).
What about effects on specific age cohorts. Machin concluded that:
Across all workers, there was no evidence of an adverse effect on employment resulting from the introduction of the NMW.
What about the effects in the most disadvantaged sectors? Machin reports on research that “searched for minimum wage effects in one of the sectors most vulnerable to employment losses induced by minimum wage introduction, the labour market for care assistants”.
He concluded that:
Even in this most vulnerable sector, it was hard to find employment losses due to the introduction of the minimum wage.
While the $26 per week increase is welcome it is insufficient to restore the relativities at the bottom of the labour market which have been eroded over recent years.
Further, today’s decision to does not redress the significant erosion of real purchasing power that low-paid workers have suffered over the last decade. I would have used the next several minimum wage decisions to ramp up the level and restore the previous relativities with the average earner and the FMWs purchasing power.
I would also note that a sophisticated society requires a decent minimum wage that is determined on the basis of what we want the floor in living standards to be. In the absence of regulation it is almost certain that the “market” would drive the wage below that level.
In such cases, the employment is not desirable and so a Job Guarantee could set the minimum alternative employment that the private employers then have to better. They need to invest and ensure productivity can support the higher wage level. Its called a win-win.
That is enough for today!