Wages growth is global Achilles heel

Wages growth is too slow, around the world, including in Australia. The impact of a long period of lower than average wages rises across the globe has fed into reduced consumption, slow inflation growth and sluggish global economic growth. The caution comes as the International Monetary Fund (IMF) forecasts global economic growth will reach 3.6% in 2016, but makes clear that the medium term risks are ‘still skewed to the downside’.

In its latest World Economic Outlook, the International Monetary Fund (IMF) calls for efforts “…to tackle the key policy challenges—namely to boost potential output while ensuring its benefits are broadly shared,...” In other words, the world must ensure that stronger global economies result in improved wages or incomes.

The IMF’s concern about wages is important, because one of the global risks is that inadequate incomes detracts from the capacity for consumption to increase. We see that, in some respects, in stagnant inflation (an IMF risk factor) and in community level concerns about global trade being the cause of lower incomes and perceptions of rising inequality that result in more inward looking global economies (another IMF risk factor).

In its latest Global Financial Stability Report, issued in October, the IMF compounds and clarifies this concern, discussing the last decade’s rise in household debt, especially the rising debt to GDP ratio.

A year ago, in 2016, the median household debt-to-GDP ratio was 63%, up from 52% in 2008. The IMF finds that there has been a trade-off between the short-term boost in growth created by increased household debt, with the medium-term risk to financial stability that could in turn drag debt down.

We can see the household debt-to-GDP ratios in the following charts, the first for advanced and the second for emerging economies.

fig 7

In an economic landscape where policy (and monetary, of course) interventions have been utterly without precedent, the opportunities for policy makers to drag on the levers of change, when they are required, is tempered by the concern that those same levers could be pulled in a manner that could drag down the global economy.

The most obvious example is interest rates, which have been dragged lower by incredible interventions by central banks since the GFC. With high levels of household debt, all central banks – the RBA included – must be cautious not to increase rates in response to inflation concerns, to the point that it creates systemic defaults that could crash economic growth.

As Greg Jericho wrote in The Guardian, there is an underlying fragility to global economic forecasts. In Australia’s case, the IMF had been predicting around 3% economic growth for 2017. Its October outlook drags that down to 2.2%, meaning that in the second half of 2017, growth will total just 1.0%.

Jericho points, in part to provide some attribution for this decline, noting that the IMF states that:

“…wage growth in most advanced economies remains markedly lower than it was before the great recession of 2008–09”

And that:

“…labour market developments in advanced economies point to a possible disconnect between unemployment and wages”.

No surprises in that for Australia, but perhaps some surprise that it is a phenomenon of the global economy right now. In its own Financial Stability Report in October, the Reserve Bank of Australia points to the international housing market, saying:

“Housing debt in a number of countries has risen from already high levels in recent years and has coincided with some evidence of riskier lending and strong growth in housing prices.”

It is not, as the RBA goes on to say, the debt itself that is the problem. It is the household debt, relative to income that is the issue, because it makes households ‘less resilient to negative shocks’.

The chart below shows the impact of a large income fall (defined as 20% of total income) and the decline in resilience, on both an income level basis and on the basis of employment type.

fig 8

What the chart shows is that all income levels have experienced an increase in the proportion of households suffering a large income fall, the major concern is the rises for lower and middle quintile income earners. Top quartile income earners may have greater income from ownership of assets, as well as lower loan to value ratios. They do have more capacity to adjust their expenditure.

Similarly, concern must exist about the rise in employees reporting a large income fall, especially compared with those who are self-employed, whose likelihood of suffering a large income fall has declined.

Again, this data feeds into calls for workers to receive higher wages. The future of their loans, their consumption, and by extension, the economy, may rely upon it.

There is much debate, and probably many reasons, why wages growth is low, even as unemployment declines. The Guardian’s Jericho points to the decline in the average hours worked each month, which as the chart below shows, has been declining for some time.

fig 9

So, pulling all of this together, with households having higher debt on average, they need their incomes to service their debt, so wages increases help pay off debt, but also may leave a little left over for increased consumption that can fuel inflation and economic growth. In previous periods as the labour market has tightened wages have grown leading to inflationary pressure. Central bankers generally try and respond ahead of such pressure by starting to move interest rates upwards. Yet, if they do that, the risk is that they will cause too much debt to be tipped over the edge, crashing financial systems in the process. 

What’s a central banker to do? Argue that wages have to increase and hope that someone takes a little notice. 

In short, conceding their hands are barely on the tiller, global central bankers are trying to conjure a little wind.