When you think about it clearly, the case for minimum award wages to be raised by 5.1 per cent is open-and-shut. So is the case for all workers to get the same. This wouldn’t stop the rate of inflation from falling back towards the Reserve Bank’s 2 to 3 per cent target zone.
But if, as seems likely, the nation’s employers contrive to ensure that this opportunity is used to continue and deepen the existing fall in real wages, the nation’s businesses will have shot themselves in the foot.
What, in their short-sightedness, they fondly imagined was a chance to increase their profits, would backfire as this blow to households’ chief source of income, crimped those households’ ability to increase or even maintain their spending on all the things businesses want to sell them.
The recovery from the “coronacession” would falter as households’ pool of savings left from the lockdowns was quickly used up, and their declining confidence in the future sapped their willingness to run down their savings any further.
Should the economy slow or even contract, unemployment could rise and the hoped-for gain in profits would be lost. Cheating your customers ain’t a smart business plan.
Such short-sighted thinking by businesses involves a “fallacy of composition” common in macro-economics: what seems “rational” behaviour by an individual firm doesn’t make sense for firms as a whole. It’s a form of “free-riding”: it won’t matter if I screw my workers because all the other businesses won’t screw theirs.
But back to wages. If all workers got a 5.1 per cent pay rise to compensate them for the 5.1 per cent rise in consumer prices over the year to March, thus preserving their wage’s purchasing power, surely that means the inflation rate would stay at 5.1 per cent?
Firms would have to raise their prices by 5.1 per cent. But many small businesses wouldn’t be able to afford such a huge pay rise and would give up, putting all their workers out of a job.
Is that what you think? It’s certainly what the employer-group spruikers want you to think. But it’s nonsense. Hidden within it is a mad assumption, that wages are the only cost a business faces.
Unless all those other costs have also risen by 5.1 per cent, the business can pass on to its customers all the extra wage cost with a price rise of much less than 5.1 per cent.
How much less? That’s a question any competent economist could give you a reasonably accurate answer to by looking up the Australian Bureau of Statistics’ most recent (for 2018-19) “input-output” tables and doing a little arithmetic.
The tables divide the economy into 115 industries, showing the value of all the many inputs of raw materials, machinery, labour, rent and other overheads to the process by which the industry produces its output of goods or services.
Any competent economist (which doesn’t include me, I’m just a journo) could do this, but only two economists from the Australia Institute, Matt Saunders and Dr Richard Denniss, have bothered, in a paper forthcoming this week, Wage price spiral or price wage spiral?
The official tables show that the proportion of total business costs accounted for by labour costs (that is, not just wages, but also “on-costs” such as employer super contributions and workers comp insurance) varies greatly between industries, ranging from less than 3 per cent in petroleum refining to almost 71 per cent in aged care.
But this “labour/cost ratio” averages just 25.3 per cent across all 115 industries.
Now, let’s assume all workers in all industries received a 5 per cent pay rise, and all businesses chose to pass all the extra cost through to prices. By how much would prices rise overall? By 1.27 per cent.
That’s going to keep inflation soaring? It’s well below the Reserve’s 2 to 3 per cent target range.
Of course, that’s just what economists call “the first-round effect”. What about when all a firm’s suppliers put their prices up to cover their wage rises? The “second-round effect” takes the overall rise in prices from 1.27 per cent to 1.85 per cent – still below the target.
Do you remember when the ABC quoted some spruiker saying the cost of a cup of coffee in a cafe could rise to $7? The authors use the tables to show that passing on a 5 per cent pay rise could increase the retail price of a $4-cup by 9 cents.
(Such people are always telling us a crop failure in South America has doubled or trebled the price of coffee beans. It’s the same trick: they never mention that the cost of beans is the least part of the price of a coffee. The biggest cost is often renting the cafe.)
Now get this. That 1.85 per cent rise in prices probably overstates the effect of a universal 5 per cent wage rise, for three reasons.
First, because it assumes zero improvement in the productivity of labour. It’s not great at present, but it’s not non-existent. Second, it assumes firms don’t respond to higher costs by shifting to cheaper substitutes.
And third, because six of the 10 “industries” with the highest labour cost pass-through are either government departments (which don’t actually charge a price that shows up in the consumer price index) or are heavily subsidised by government. Effect on the budget isn’t the same as effect on inflation.
Note that whereas the Fair Work Commission has the ability simply to order a 5 per cent rise in the many minimum award rates covering the lowest-paid quarter of the workforce, should it choose to, the public and private sector employers of the remaining three-quarters of workers are unlikely to be anything like that generous.
That’s a fourth reason the effect of wage rises is likely to be (a lot) less than the authors’ simple calculation of a 1.85 per cent rise in retail prices.
But don’t get the idea wages are the only reason consumer prices rise. Wage rises would explain little of the 5.1 per cent rise in consumer prices over the year to March.
The great bulk of the rise is explained by businesses passing on to retail customers the higher prices of imported goods and services caused the pandemic’s various supply disruptions and the Ukraine war’s effect on energy and food prices.
But some part of that 5.1 per cent rise in prices is explained by businesses deciding now would be a good time to raise their prices and fatten their profit margins. This may not be a big factor so far, but I won’t be surprised if it’s a much bigger one this quarter and in future.
For months the media have been telling us how much a problem inflation has become, with a lot worse to come. Top business leaders and industry lobbyists have used naive reporters to, first, send their competitors a message that “we’re planning big prices rises so why don’t you do the same” and, second, soften up their customers. “Prices are rising everywhere – don’t pick on me.”
It’s quite possible we’ll have trouble getting inflation back into the target range. If so, it won’t be caused by big pay rises – but it’s a safe bet people will be using a compliant media to blame it on greedy workers.
