Job markets and the economy

If I had to single out one big issue which deserves the highest priority at the 2020 Summit, it is the capacity of the Australian economy to sustain low unemployment - say in the range of 3 to 4 per cent - without running into inflationary demand pressures. If the Rudd Government cannot solve this basic problem, its noble vision of a fair and productive society will be tarnished.

Australia is currently facing an inflation problem. In good part, the recent acceleration in underlying price rises is a product of cost-push forces but, rightly or wrongly, the RBA has decided that the growth in domestic spending is excessive and needs to be reined back. The Bank is aware of other forces bearing down on demand - such as the high Australian dollar, the slow-down in world economic growth, the share market slump, the increased aversion to risk in debt markets and the lagged effect of past rises in borrowing costs - but it clearly believes that, without monetary tightening, these factors will not do enough to reduce rising inflation expectations or discourage wage demands.

In its February 2007 statement on monetary policy, the RBA forecast that with unchanged policies, non-farm GDP growth would slow from 4.3 to 3 per cent per annum by 2009-2010. Since then it decided to raise official rates by a further ¼ per cent. One can therefore surmise that it is aiming to slow GDP growth down to 2.5 to 3 per cent in order to bring inflation under control.

With the labour force growing by 1.5 to 2 per cent per annum and with underlying labour productivity growth of 1.5 to 2 per cent, it is clear that the Bank is resigned to seeing unemployment rise, at least in the short term. It may have formed the view that the present unemployment rate of 4.1 per cent is unsustainable because it is below the “equilibrium” rate of unemployment consistent with non-accelerating inflation - the so-called NAIRU.

The latter has been estimated by Treasury to be as high as 5 per cent. So even if the actions of the authorities all went to plan, we are going to have to sacrifice some jobs in order to achieve good inflation outcomes.

This is the immediate economic reality we realistically face. But it would be tragic if the authorities were now to accept that over the next few years Australia will not be able to sustain an unemployment rate much below 5 per cent. It would mean that, after discounting for those who are in transition from one job to another, we would be resigning ourselves to having at least 300,000 officially unemployed people, and half as many again of unofficial (hidden) jobless, who want to work but are unable to fill the vacant jobs.

Apart from the personal hardship it would entail, this scenario would represent a huge waste of productive potential. And it would all be due to wage rigidities and barriers to geographic and occupational mobility - a kind of “market failure” stemming in part from “government failure”.

It is not necessary to adopt such a defeatist policy on the NAIRU. Much can be done through policy reform (mainly “micro”) to get unemployment down below 4 per cent without the risk of accelerating inflation.

This is not just an issue for 2008 or 2009. It is one which will keep recurring in the future so it rightly belongs to the long term agenda.

Need for more research

A government wanting to reduce the NAIRU should first determine WHY there are so many jobless persons unable to fill available jobs. Is it because their productivity is too low relative to the minimum award wage? Is it because they lack the education, training or social skills to fill the available jobs? Is it because the jobs offer family-unfriendly environments? Is it because the jobs are poorly located relative to where the jobless live? Is some of the joblessness due to a “welfare culture” or the product of social dysfunction and lack of personal responsibility?

Some research has already been done on these questions but more is needed.

Lowering the NAIRU

Once the authorities understand the nature of structural joblessness in Australia, they are in a better position to design the right strategy to fix the multi-faceted problem. And they must do it in a way which spreads the costs and benefits equitably across the population. The electorate has made it clear in its response to WorkChoices that it will not tolerate policies which put the main adjustment burden on the most disadvantaged in our community.

To be effective, the strategy must allow reasonable room for structural wage flexibility, for example, through radical award simplification. And it must incorporate most of the present tough welfare to work measures. These “neo-liberal” measures are unpalatable to many but necessary to ensure markets work in conjunction with governments - not against them - and that the demands on taxpayers are not excessive.

But neo-liberal policies should also be backed by measures designed to protect the incomes and enhance the productivity, employability, work readiness and incentives of the low-skill, low-ability workers and to prevent the perpetuation of chronic inter-generational joblessness. The types of measures needed could be drawn from the following illustrative list of options - most of them successfully applied in Nordic and European countries:

• tax offsets or credits to compensate low income workers;
• wage subsidies to employers to induce them to employ low-skilled, low-ability workers in disadvantaged areas;
• improved adult education and training opportunities;
• adequate relocation incentives to encourage people to move to booming parts of the employment market;
• more family-friendly policies (for example, more flexible working patterns, parental leave and good quality and affordable child care assistance);
• a redesign of fiscal policies to help address the geographic and regional imbalances in employment opportunities and the insensitivity of monetary policy to such imbalances;
• measures to correct early childhood disadvantages (in cognitive skills and non-cognitive aptitudes like social skills and motivation) stemming from low parental income and education, poor parental attitudes, dysfunctional home environment, neighbourhood factors or exposure to poor role models or pervasive irresponsibility;
• remedial programs for older school children and youth (age 14-19) who are under-performing and at risk of dropping out early from high school;
• lifelong learning incentives targeted at vulnerable groups, putting some of the onus on business too; and
• improved access to key employment-enhancing public services like health, housing and public transport in low-income areas.

This “liberal-interventionist” strategy would allow Australia to sustain low rates of unemployment (3 to 4 per cent) with low and stable underlying inflation. It would be largely self-funding in the long term because it would increase the productive base of the economy and thus generate additional revenue. But in the short term there would be a net demand on revenue.

To minimise by-product economic efficiency costs, the revenue gap could be funded by broadening the tax base (such as clawing back some of the tax advantages of superannuation and capital gains and other middle-class welfare) and by increasing taxes on activities with negative externalities (such as those which generate greenhouse gases and traffic congestion). To pay for longer term capital projects, some temporary government borrowing would also be justified.

Ultimately, the strategy would have lots of winners but very few outright losers. The low paid worker would, at worst, be unaffected in net terms; the unemployed would be better off; taxpayers generally would pay more tax in the short term but they would have more than offsetting gains from lower inflation, lower mortgage costs and a stronger economy with good job opportunities.

As well as making sure that the labour market of the future is able to deliver adequate structural wage flexibility and occupational and geographical mobility, the authorities need to look critically at the adequacy of the present RBA measure of “underlying inflation” as a trigger for interest rate increases: does it truly reflect excess demand pressures in the economy and does it discount fully for “cost-push” factors? And they should ask themselves why a temporary non-accelerating inflation rate of, say, 3.5 to 4 per cent poses greater economic and social risks than an unemployment rate of 5 to 6 per cent. The 2020 summit will hopefully face up to these critical issues.