Date posted: 12/12/2018 10 mins min read

Productivity is up, why not wages?

Finding a fix for the broken relationship between productivity and wage growth is a key challenge for Australian and New Zealand policymakers.

In Brief

  • Wages growth is unusually low, even in countries with unemployment rates at 5% and below, which traditionally signals full employment.
  • Since 2000 in Australia, labour productivity has risen by almost 26%, but real wages by just 13%. In New Zealand, productivity has risen by 23% and real wages have remained unchanged.
  • Saul Eslake says we need to find a way to better share the rewards of productivity growth between employers and employees, or risk the rise of extremist populist politics.
By Saul Eslake

One of the more important challenges currently confronting both economic policymakers and political leaders across almost all ‘advanced’ economies is the unusually slow growth in both nominal and real wages, despite continued economic growth and declining unemployment.

During and immediately after the global financial crisis (GFC), when unemployment in most advanced economies was at its highest level since the early 1980s – if not the Great Depression – it was no surprise that wages growth slowed sharply.

What has been surprising is wage growth has been at historically low levels since then, despite the gradual but ongoing economic recovery of the past decade. In particular, wages growth has remained unusually low even in countries where the unemployment rate is currently well below what’s traditionally regarded as signalling full employment, such as the US, UK, Japan and Germany.

Wages and productivity unlinked

With the benefit of hindsight, it’s obvious that the historical relationship between wages growth and the state of the labour market in advanced economies had begun to change well before the global financial crisis.

Australian workers were to some extent shielded from these developments by the resources boom of 2005-2013, which saw employers in the resources sector bidding up wages to attract people to work in remote and challenging locations. This, in turn, forced employers in other sectors to raise wages in order to retain their own staff.

During this period, unemployment in Australia remained lower than in most other advanced economies. But once the resources boom began to fade, and unemployment and under-employment began to rise, wages growth in Australia slowed to a rate similar to other advanced economies.

In contrast to Australia, New Zealand experienced a recession during and after the GFC; unemployment rose sharply, and wages growth greatly slowed. Since 2013, unemployment in New Zealand has been declining steadily, and has been below the 5% level usually regarded as commensurate with full employment since the beginning of 2017. Despite this, wages growth in New Zealand has remained below 2%.

"The divergence between real wages and labour productivity… is at variance with one of the most widely accepted propositions of conventional economic theory."
Saul Eslake

What’s been particularly striking has been the divergence between real wages and labour productivity, which is at variance with one of the most widely accepted propositions of conventional economic theory.

In Australia, labour productivity has risen at an average annual rate of 1.3% since the turn of the century – or by almost 26% in total (Chart 1). But real wages, measured from the standpoint of employees (deflating nominal wages by consumer prices), have risen at an average annual rate of only 0.7% (or by 13% in total); and measured from the perspective of employers (deflating by the price deflator of GDP), at an average annual rate of 0.4% (or just 8% in total).
Labour productivity Chart 1: Labour productivity and real wages in Australia (Click image to enlarge) Note: the real consumer wage is the wage cost index deflated by the CPI; the real producer wage is the wage cost index deflated by the implicit price deflator of non-farm GDP. Sources: Australian Bureau of Statistics and author’s calculations. Chart 2 Labour Productivity Chart 2: Labour productivity and real wages in New Zealand (Click image to enlarge) Note: the real consumer wage is the labour cost index deflated by the CPI; the real producer wage is the labour cost index deflated by the implicit price deflator of GDP. Data is only available for March years.
Sources: Statistics NZ and author’s calculations.

Real wages fall in NZ

In New Zealand, labour productivity has risen at an average annual rate of 1.2% so far this century, or by 23% in total – only a little less than in Australia. But real wages, from employees’ perspective, have been unchanged; while from an employers’ perspective, they have actually fallen by 2% over the past 17 years (Chart 2).

The experience in both countries suggests that boosting productivity growth – desirable though that would be on many grounds – would not necessarily result in faster growth in real wages.
Ironically, the fact that real wages have grown by less than labour productivity on both sides of the Tasman has probably facilitated faster growth in employment by encouraging employers to substitute labour for capital. But that substitution of labour for capital is one reason why labour productivity, in both countries, has grown more slowly since 2000 than during the 1990s. And that, in turn, is a major reason why growth in real per capita GDP has been significantly slower over the past 18 years than it was during the 1990s (Chart 3).
GDP growthChart 3: Real per capita GDP growth, Australia and New Zealand, 1991-2018 (Click image to enlarge)
Sources: Australian Bureau of Statistics, Statistics NZ.

So although the profits share of national income in Australia and New Zealand has been well above its long-run average in recent years, both the level and the growth rate of profits – the principal yardsticks by which shareholders and analysts measure business performance – had been lower than they would have if both countries’ overall economic performance been stronger.

NZ households now spend more than they earn

In Australia, households have sought to maintain their spending in the face of a steady decline in real household disposable income by setting aside less of their income in savings – to the lowest level since before the GFC – and taking on record amounts of debt. But now that property prices have begun to decline almost everywhere in Australia, households are probably less likely to keep doing that.

In New Zealand, the household saving rate has been negative – that is, households have, in aggregate, been spending more than they’ve been earning – since 2015, something which surely can’t continue indefinitely.

On both sides of the Tasman, maintaining – let alone improving – the rates of economic growth will also require finding ways to ensure that the rewards of productivity growth are fairly shared between employers and employees. A failure to do so would probably see a more marked swing towards the more populist politics now evident in the US and Europe, which so far have been less apparent in Australia and New Zealand.

Saul Eslake is an independent economist, speaker, company director and Vice-Chancellor’s Fellow at the University of Tasmania.

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