There was an article in Bloomberg Op Ed yesterday (May 19, 2015) – U.S. Workers Brought the ‘Great Reset’ on Themselves – which argues that those who bemoan the falling standards of living for workers in terms of job stability, real wages growth etc have only themselves to blame because as workers they demand conditions that they are not prepared to sustain as consumers and taxpayers (higher prices, higher taxes). It is an extraordinary argument not because there are not elements of truth in it, but, rather, because it ignores other realities such as the rising income inequalities and the on-going redistribution of national income to profits. It also tallies with what is going on in Australia at present, which is a specific form of the on-going attack on real standards of living for workers and their families through poorly crafted government policy. The policy design reflects ideology rather than any appreciation of what is required to maintain living standards.
Last week, the Chairperson of the Australian Securities and Investments Commission (ASIC) which regulates companies and enforces consumer laws relating to credit etc) made the rather surprising intervention into the public debate by claiming that the monetary policy settings of the Reserve Bank of Australia (RBA) were endangering property investment.
On May 5, 2015, the RBA cut its target policy interest rate to 2 per cent (an all-time low). In the – Statement by Glenn Stevens, Governor: Monetary Policy Decision, the RBA said:
In Australia, the available information suggests … the key drag on private demand is likely to be weakness in business capital expenditure in both the mining and non-mining sectors over the coming year. Public spending is also scheduled to be subdued. The economy is therefore likely to be operating with a degree of spare capacity for some time yet. Inflation is forecast to remain consistent with the target over the next one to two years, even with a lower exchange rate …
The Australian dollar has declined noticeably against a rising US dollar over the past year, though less so against a basket of currencies. Further depreciation seems both likely and necessary, particularly given the significant declines in key commodity prices.
So the RBA realises that the national economy is weak and that government spending is not helping to stimulate growth. The contribution of the government sector to growth in the last quarter was negative.
The Chairman of ASIC’s angle was that the low interest rates are creating a housing bubble, particularly in Sydney and Melbourne (the two largest capital cities in Australia).
He was quoted as saying ((Source):
I am quite worried about the Sydney and Melbourne property markets. In housing, the long-term average income to average price ratio is four to five times, but at the moment it is at historic highs … There is always danger when rates get so low. That’s when people start borrowing when they can’t afford it. What generally happens is rates start to rise, which affects your ability to pay, and rate rises can actually burst a bubble, so you end up with a double whammy …
History shows that people don’t know when they are in a bubble until it’s over …
I last covered this topic in the following blog – Monetary policy is largely ineffective.
The ABS publish the – Residential Property Price Index – the latest release for the December-quarter 2014 being published on February 10, 2015.
The following graph shows the movement in this Index for the capital cities in Australia since the September-quarter 2003 until the December-quarter 2014.
The spike in Sydney residential property prices since 2013 is noticeable. This is the concern expressed by the RBA in its decision (as above).
The ABS data is quarterly. Using other – information – which provides data on a monthly basis, we learn that the Sydney property market inflated by 14.46 per cent in the year to April 2015, while the Melbourne market inflated by 6.94 per cent over the same period.
The following graph shows the annual growth in property prices from the September-quarter 2011 to the April 2015 for Sydney and Melbourne. This is approximately the period over which the RBA has cut the target policy rate from 4.75 per cent to 2 per cent.
Whether that growth constitutes a bubble is one question. It is not clear that there is an acceleration in the rate of growth of prices (probably not) but then the current level could be unsustainable.
If we assume that property prices in Australia’s major capitals are growing quite robustly, why is that a problem?
The problem is that it is coinciding with the deliberate strategy of our government to cut our living standards, even if they claim to be doing otherwise.
In addition to acknowledging the sluggish nature of the Australian economy, the RBA also implicitly knows that by lowering interest rates it not only stimulates local credit markets (how much is the question and the unknown) but also helps to reduce the value of the Australian dollar, which may or may not stimulate net exports.
But lower interest rates also reduce the standard of living of segments of the population who rely on fixed incomes (retirees etc), which is one of the reasons the impact on overall spending is ambiguous.
The impacts via the exchange rate, also undermines living standards of residents because of the high reliance on imported goods.
So the effect of monetary policy in isolation at present is to reduce real standards of living.
With real wages growth flat or negative and productivity rising the gap between the two has continued to increase, which means that to maintain consumption growth at levels commensurate with the supply of goods and services onto the market, households have to rely on credit expansion.
Further, private consumption is the main driver of the weak growth in Australia at present as the government sector seeks to impose increasing austerity, private investment spending is flat and net exports are draining growth.
The lower interest rates can only stimulate growth if there is more private debt. We have similar dynamics to those that existed prior to the collapse. The same trends are occurring in other advanced nations.
This comes at a time when household debt remains at very elevated historic levels.
RBA provides relevant data – Household Finances – Selected Ratios – E2
The next graph shows total household debt as a percentage of disposable income since 1980 (to December-quarter 2014). The blue line is total and the red housing mortgage debt.
The credit binge was stark and in two decades pushed the ratio up from an historically steady 40-45 per cent to a peak of 152.9 in the September-quarter 2006.
At that point, the balance sheets of the households holding this debt became very precarious and the rising unemployment and falling economic growth that followed threatened major debt delinquencies.
Since the onset of the crisis and the rise in unemployment, there was a flattening out of the debt ratio. The trend is now upward given that the ratio has risen for the last 8 consecutive quarters (last 2 years)
This is the point that the ASIC Chairman is worried about. Chasing higher residential prices with ever-larger residential mortgages is a recipe for disaster at a time when fiscal austerity and weak private spending is undermining overall national income growth and pushing unemployment up.
Household interest payments to income were 5.3 per cent in the March-quarter 1977 and they are now 8.9 per cent. Before the RBA embarked on their latest interest rate cutting round the interest burden peaked at 13.2 per cent of household disposable income (September-quarter 2008).
Given the huge debt liabilities now carried by Australian households, any increase in interest rates immediately pushes the burden up into worrying thresholds.
In that sense, the cut in interest rates has helped increase the living standards of those holding large outstanding debts.
The problem the RBA finds itself in is that by dint of the deliberate fiscal strategy employed by the federal government to cut net public spending and therefore kill off growth and push up unemployment, the central bank is the only policy institution that can (theoretically) safeguard against recession.
But as I have noted previously, this reliance on monetary policy to stabilise economic growth and prevent unemployment from rising further is fraught.
The reliance on monetary policy is also compromising other policy goals – hence the concern about property prices.
It is a case of having too many objectives with not enough policy tools. I discussed the theory relating to that statement in this blog – Monetary policy is largely ineffective.
A stable outcome is not possible. If property prices get out of control, the RBA has only one tool to discipline them – pushing up interest rates.
This will work against (in their minds) the goal of stimulating a weakening economy.
Meanwhile, workers’ living standards continue to decline.
The solution is obvious but outside the neo-liberal Groupthink that dominates economic policy making.
Fiscal policy needs to be significantly more expansive and then monetary policy does not have to play the counter-stabilising function exclusively.
Fiscal policy (particularly tax policy) can target segments of the economy that might be overheating. Spending on increased state housing will also reduce the growth of residential housing prices in the capital cities. There is a major shortage of such housing as governments have cut back provision – another casuality of austerity.
Further, imagine if we resumed the pre-neo-liberal era behaviour and real wages grew in proportion with labour productivity. In other words, the balance of power between workers and capital was shunted back to workers a bit – to restore the losses that have been realised under the neo-liberal onslaught.
The neo-liberal era began around the early 1980s (give or take). To keep the numbers rounded lets start history in Australia in the March-quarter 1982. The wage share in total factor income was an even 60 per cent. The profit share in total factor income was 17.8 per cent.
By the December-quarter 2014 (the most recent data), the wage share was at 53.3 per cent and the profit share was at 26.4 per cent.
Average non-farm compensation per employee was paid $A4,376. The index for GDP per hours worked (productivity) was 60.3. By the December-quarter 2014, the average pay was $A18,215 and the index for GDP per hours worked was 103.1, an increase since the March-quarter 1982 of 71 per cent.
The real wage index that expresses the Average non-farm compensation per employee in real terms (using the implicit price deflator) grew by 26 per cent.
For the wage share to remain constant, real wages has to grow in line with labour productivity. Please read my blog – Australian wages growth – lowest on record – for more discussion on this point.
You might wonder what would have happened if the wage share had not been attacked by punitive anti-union legislation and persistently high unemployment.
I did a rough simulation of the average wage per employee if the real wage had have kept pace with productivity growth (and assuming the inflation rate followed its historical path).
Assuming that from the March-quarter 1982, the real wages growth was equal to labour productivity growth, the Average non-farm compensation per employee in the December-quarter 2014 would have been $24,720, instead of $A18,215, a difference of 35 per cent.
That is a lot of extra purchasing power and the dynamics of the economy would have been substantially better had that outcome or something similar to it occurred.
The claim by the neo-liberals has always been that the redistribution of national income towards profits would stimulate employment because it would increase the investment ratio. Firms would reinvest the extra profits into new productive capital.
In 1982, the Investment-ratio (total investment as a percentage of GDP) was around 22 per cent. By the December-quarter 2014 it stood at 22.3 per cent.
So no substantial shift in the share of productive investment in the economy. The non-mining investment ratio is now much lower.
Some of the redistributed national income over the last 30 years has gone into paying the massive and obscene executive salaries that we occassionally get wind of.
Most of it has been funnelled into the increasingly deregulated (and out of control) financial markets which has fuelled the speculative bubbles around the world. These bubbles crashed in 2008 but with government bailout support are now back on track again
For workers, the problem is that they rely on real wages growth to fund consumption growth and without it they borrow or the economy goes into recession. The former is what happened around the world in the lead up to the crisis (and caused the crisis).
The latter is more or less what is happening now.
It might also be argued that if the real wage had have grown that much then inflation would have been higher. But this claim falls by the wayside because labour productivity growth provides the non-inflationary space for real wages to grow. So as long as real wages grow in line with productivity, real unit labour costs do not rise (the wage share is constant) and there are no inflationary forces arising from labour costs.
The point is that under neo-liberalism a set of dynamics were set in place that invoked the instability properties built-into the capitalist system of production and distribution.
The GFC was a culmination of the first round of this breakdown. In the aftermath of the GFC, the neo-liberal logic is still being applied with workers bearing more pain when the opposite should be the case.
There would be less need of credit because workers could fund their consumption from real wages growth. There would be less funds flowing into dubious financial market firms – that is, less gambling chips available.
Material living standards for all would be higher rather than for the top 1 per cent. Workers would again gain a fairer (and economically more stable) share of the national income that they produce.
At present, government fiscal and monetary policy is deliberately working to undermine living standards. It is a more subtle process than the developments the Bloomberg article cited in the introduction outlines.
But effectively, the neo-liberal dynamics have been restored after the shock and disruption of the GFC.
It is a dark time.
That is enough for today!
(c) Copyright 2015 William Mitchell. All Rights Reserved.