Skills mismatch: Reserve Bank sees wage growth rising to levels not seen in more than a decade

A shortage of people to fill the jobs on offer is expected to see wages rising at the fastest rate in more than a decade, as employers bid up the price of labour.

The latest forecasts from the Reserve Bank on Wednesday show that the labour cost index – a measure of general wage inflation – is expected to increase from 1.6 per cent in March to 2.4 per cent by the end of the year and remain at high levels for the next few years.

The rise might sound modest, but if the forecasts prove correct it would represent the strongest rise in wages since before the global financial crisis, economists at Westpac said.

At a briefing for MPs on Thursday morning, Reserve Bank chief economist Yuong Ha said nominal wage growth could be about 2 percentage points higher than the labour cost index.

As well as being more confident that the economy will continue to expand out of Covid-19, the strength of the labour market appears to be what is underpinning the Reserve Bank’s signals that it will begin a series of interest rate increases from the middle of next year.

The expectation on wages appears to based around an expectation that a shortage of people with skills needed to do certain jobs – a long running concern of business which has been intensified by closed borders – will see employers forced to up wages to fill vacancies.

Members of the Reserve Bank’s monetary policy committee said they “expect to see wage growth lift as firms compete for labour, in particular given the current low levels of immigration”.

But the spoils may not be enjoyed by everyone. At the same time as wage growth is expected to accelerate and stay higher than normal for several years, there is expected to be only a marginal fall in unemployment from current levels.

In March, unemployment dropped to 4.7 per cent. The Reserve Bank only forecasts unemploymentwill gradually drop to 4.3 per cent over the next few years.

Meanwhile, the sharp rise in wages is not expected to lead to a persistent increase in inflation.

Economists appeared to question the argument put forward by the Reserve Bank.

Bagrie economics managing director Cameron Bagrie said a hike in the minimum wage in recent years and other government measures supported strong wage growth.

However Bagrie said the Reserve Bank continued to forecast low productivity growth, meaning higher wages would eat into business margins, yet the central bank was not forecasting high inflation.

“That’s a pretty big judgement, as typically, you do see some sort of spillover effect. If you’re a business absorbing higher wages and you’re not passing the costs on, something happens to your margin,” Bagrie said.

“There’s no free lunch here. We are going to pay in some shape or form,” he said, likely to mean small business margins would come under pressure.

The Reserve Bank’s statement did acknowledge the risk that rising wages could lead to inflation, which could in turn lead to more pressure for wage increases.

“If households and businesses perceive an increase in inflation to be persistent, they are likely to respond by asking for higher wages to compensate for a higher cost of living or by setting higher prices,” the Reserve Bank said.

“This can become self-fulfilling, as higher actual wages and prices can lead to higher expectations for future inflation.”

Lump of labour

Westpac acting chief economist Michael Gordon said he did not agree with the Reserve Bank’s argument, pointing to the fact that unemployment had fallen further and faster than the market had expected as the country moved out of lockdown.

“We’ve all been surprised at how much it translated into employment growth so it seems strange to take the lesson that it’s suddenly going to stop,” Gordon said.

There may be examples where employers bid up pay by competing for workers, Gordon said, but it may not be widespread enough to show up in nationwide pressures.

“It may show up in wages for certain jobs that were more reliant on access to migrants, but that does not mean it applies at a national level which is what the Reserve Bank is meant to be forecasting.

Gordon believed the argument may fall into the “lump of labour fallacy” which assumes that there is a set amount of work in the economy to be shared, which was often behind the belief that migrant workers suppressed wages. International evidence suggested that migrants entering the labour market created roughly the same amount of demand as they absorbed.

Changes in migration had not tended to be related to swings in the labour cost index, Gordon said.

“We’ve been through this before. We’ve had net migration at zero, or negative, before, in the last couple of decades. It did not correlate with changes in the wage growth trends.”

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