The labour market and the downturn

The Australian economy is entering a period of below average economic growth, a definite downturn in the business cycle. This downturn may well be a recession, with total production (real GDP) falling. The biggest danger of this recession is unemployment, with the number of unemployed set to rise rapidly to levels that haven’t been seen since the early 1990s recession. Are current policies doing enough to help the labour market get through the downturn?

The economic forecasts are dim. Even with the recent stimulus package Treasury predicts that economic growth will slow to 1 per cent for 2008-09 and then 0.75 per cent in 2009-10. Output contracted by 0.5 per cent in the December quarter according to the first estimates. Yet the situation won’t be as bad as in many other industrialised countries, which the IMF expects will contract by 2 per cent on average in 2009, with global growth slowing to just 0.5 per cent. The turmoil in global financial markets and synchronised recessions in many trading partners are ongoing negative shocks to both our banking system and net exports. Although unemployment will increase, the government and Reserve Bank have been doing what they can to minimise the damage through interest rate cuts and fiscal stimulus packages.

Labour market prospects

A recession is as severe as the unemployment it causes. Higher unemployment reduces consumer incomes and confidence further, with some external or government stimulus usually needed to generate an economy recovery. The unemployment rate rises swiftly in a recession and remains high for some time afterwards. Unemployment typically takes longer than economic growth to recover because employers only hire new staff once they are sure the upturn will last and they can afford to keep them. The average duration of unemployment and the number of long-term unemployed also rise in recessions, and while these people are out of work they miss out on experiences and skill development provided by the adjusting economy, making it harder to find jobs once the economy recovers (a process called hysteresis). These dynamics can be seen for the early 1980s and early 1990s recessions in Graph 1.

Graph 1: Australian trend unemployment rate, Feb 1978 - Jan 2009 (Source: ABS).

Unemployment is already rising now. There were 598,600 unemployed workers in January, with three-quarters looking for full-time work, up from 502,400 a year earlier. The number of unemployed is now at January 2006 levels, which was still part of the boom period. Unemployment has much further to rise. The unemployment rate hit a 34-year low of 3.9 per cent in February 2008 and has since risen to 4.8 per cent. In January employment grew by 1.2 per cent, already showing signs of a sharp slowdown. The number of vacancies is slowing sharply. The labour force participation rate has fallen slightly to 65.1 per cent, but is still near its record high of 65.5 per cent last April. In trend terms, full time employment has been declining slightly and part time employment growth is slightly positive.

The forecasts are much grimmer. Treasury expects total employment will grow by just 1 per cent in the 2008-09 financial year. During 2009-10 employment is anticipated to fall by 0.75 per cent, then grow by 1.25 per cent in each of the following two years. The unemployment rate is forecast to rise to 5.5 per cent by the end of this financial year, then to 7 per cent during 2009-10. Headline-grabbing job losses are already occurring. These forecasts imply that the number of unemployed will rise 30 percent to over 780,000. Yet like all economic forecasts, there is a risk that things could turn out worse than currently expected.

Implications

How much will the unemployment rate rise in the downturn? This depends on the “natural” rate of unemployment, which is determined by structural labour supply factors, such as the preferences, skills and employability of the workforce (but not cyclical changes in labour demand). Although this natural rate cannot be measured or observed, most economists believe that when the economy grows faster than its long-run growth rate, unemployment falls below the natural rate and inflation rises. When economic growth slows, unemployment rises above the natural rate.

If the natural rate is high (for example, at about the 7.2 per cent average unemployment rate since 1978) then we will see a big rise in the unemployment rate. Fortunately, estimates by Steven Kennedy of Treasury put the natural rate at somewhere between 4.5 and 5 per cent in June 2007, suggesting the unemployment rate will not go as high as it has in past recessions. (The natural rate is likely to have fallen in the past decade due to strong productivity growth and changes to labour market regulation and unemployment assistance.)

However, even if the forecast rise in the actual unemployment rate to 7 per cent is small by historical standards, there will be other developments in the labour market. Long-term unemployment will rise as those who have lost their jobs find it even harder to obtain new ones. The unemployment rate also excludes a large number of people who do not match the official definition of being willing and able to work while actively looking for it. This group includes discouraged workers (who give up looking for work, quitting the labour force), those who retire early because they can’t find a job, those who give up unemployment benefits and go on the disability pension instead, and those who might have entered the labour force had jobs been available (school graduates, some mothers, and so on).

An increase in the size of these groups - the “hidden unemployed” - typically occurs in recessions, and explains why the labour force participation rate is predicted to drop by a whole percentage point over the coming downturn (to 64.5 per cent).

Unemployment statistics are also headcount measures of people, and are thus poor measures of labour underutilisation. Underemployment, or the amount by which actual hours work fall short of workers’ desired hours, is also important. Full-time employment growth tends to drop much faster than part-time employment growth in recessions as employers cut back on hours and stop hiring permanent full-time staff.

The ABS estimates that 5.2 per cent of available labour hours were underutilised in September 2007. By contrast, the Centre of Full Employment and Equity at the University of Newcastle estimates that the hours-adjusted rate of total unemployment (which they term CU8) was 9.1 per cent around this time. In the November quarter of 2008 this was up to 9.3 per cent, yet still well below the 13.4 per cent recorded in early 2002. If this is any indication, the total amount of labour underutilisation is likely to rise a lot more than the unemployment rate will in the current downturn. Various measures of labour underutilisation are presented in Graph 2.

Graph 2: Selected measures of labour underutilisation for Australia, 1986-2008 (Sources: ABS, CofFEE. ABS figures for September, CofFEE for August quarter).

Furthermore, particular segments of the labour market are affected worse than others in downturns, such as unskilled workers, NESB migrants, indigenous Australians and female casual and part-time workers. Unemployment and underemployment also tend to hit some industries and regions worse than others, particularly those already in decline (e.g., car-manufacturing in South Australia). When real wages fall in recessions, many workers in disadvantaged groups (who tend to be concentrated in low-wage occupations) that do keep their jobs also tend to suffer worse than others.

Policy options

There are a number of options available to mitigate these effects. A mixture of macroeconomic, industrial relations and unemployment policies are required during the recession and throughout the recovery period. Workers, skills and jobs must be better aligned in an efficient and timely manner.

Recent fiscal and monetary stimuli by the federal government and Reserve Bank will most likely take over a year to kick in fully, yet will do a lot to minimise the extent of the downturn and rise in unemployment. Solid fiscal and monetary management since the early 1990s has meant that any recession here will not be as severe as in other countries. The government anticipates its fiscal stimulus packages and budget deficits will boost economic growth by 0.75 to 1 per cent by 2009-10 and preserve 90,000 jobs over the two years. Macroeconomic policy has entered a highly stimulatory phase and will exert a positive effect on labour demand.

Industrial relations and labour market policies also have a role to play by minimising job losses in the downturn. In a recession, most employers are unwilling to increase their costs by hiring more workers no matter how low wages fall, because deficient aggregate demand creates no incentive to expand output. Calls by business lobbies for the Rudd Government to scrap its proposed industrial relations laws, or to pressure the Fair Pay Commission to lower the minimum wage, thus aren’t persuasive strategies to boost aggregate demand and employment.

Rather, the focus needs to be on avoiding as many retrenchments as possible and ensuring that, once economic growth reappears, workers who lost their jobs are able to easily re-enter employment. Since most workers possess firm-specific knowledge and skills, and employers incur on-costs when they hire workers again, firms tend only to sack workers en masse as a last resort. There is thus scope to give firms greater flexibility to reduce workers’ hours while keeping them employed.

The Rudd Government’s new industrial relations laws have been controversial, but the economy’s short term problems need to be considered separately from the reforms’ long-run impacts on bargaining power and labour productivity. Temporary measures could be considered to assist firms to reduce workers’ hours and adjust employment contracts accordingly. The focus at the moment - for government, employers, workers and the unions - should be on retaining jobs rather than on re-weighting bargaining power or securing higher wage increases.

Several proposals have been put forward, such as a reduction in the minimum wage that is offset by a higher tax-free income threshold, leaving workers no less off but reducing costs to firms. Yet with deficient aggregate demand this may not do much more than permanently reduce tax revenues while low skilled employment is largely unaffected. Other schemes involve expanding job sharing, subsidising employment for unskilled workers and providing more funding for on-the-job training and apprenticeships. In one option, workers could take leave for several weeks at a time with the government paying them the unemployment benefit during this period.

Whatever schemes are implemented, the government needs to make sure that working remains sufficiently attractive compared to welfare, yet that unemployment benefits are still sufficient for the jobless to support their families on. Indeed, there is scope to adjust the obligations placed on recipients of the Newstart Allowance (unemployment benefits). Until recently, many of the NA rules were set to cajole the long-term unemployed into finding work in a booming labour market. The government has started to soften the assets tests for receiving the NA and is reforming penalties for rule infringements.

An extra $298.5 million in funding for the privatised employment services system has also been announced, to ensure that workers immediately qualify for job search assistance when they become unemployed (rather than having to wait three months). Extra funding will be provided for an additional 10,000 places in training programs to develop workers’ skills and facilitate transition towards work in different industries.

More resources must be provided to the Job Network agencies that help people to find work (and are now dealing with a growing number and diversity of jobseekers). There needs to be better oversight and regulation of labour market programs and how they are implemented (particularly in terms of assisting individual jobseekers), and improved co-ordination with - and funding of - education providers, especially TAFE. Well-targeted training is a valuable way to ensure workers’ skills can keep pace with evolving industry mixes and labour demand.

Specialised programs that target disadvantaged groups in the labour market, such as school leavers, NESB migrants, Indigenous Australians and single parents, also need to be devised or expanded. The long-term unemployed should be given additional assistance too, as a rise in the size of this group during a downturn can be very difficult to get back down afterwards.

A mixture of policies is needed to avoid serious labour market problems in the coming downturn. The last thing we need is a big rise in unemployment. Yet this downturn is not going to be as bad as in many other countries. With the right policies, we can not only reduce its severity, but also increase our labour productivity and economic efficiency well into the future by improving workers’ skills, encouraging greater workplace flexibility and dealing with the jobless more efficiently.