Invest in productivity to break the wage-inflation nexus

If we drive productivity, and link wages growth to ­productive effort, then we can indeed pay for higher wages to sustain people’s incomes, while not ­burdening the cost side of the equation.

The current debate about wages is important but the way to achieve higher wages, and indeed more jobs, is through a debate about productivity and investment. If Australians want a prosperous future for ourselves and our kids, then we have to get the basics of the growth equation right.

There are two sides to thinking about wages – they represent income for people on the one hand, and a cost to business on the other.

But if we drive productivity, and link wages growth to ­productive effort, then we can indeed pay for higher wages to sustain people’s incomes, while not ­burdening the cost side of the equation.

But Australia is not investing enough to drive productivity.

It’s actually as simple as that.

For too long now in Australia, wage growth has been subdued. In the days of the Accord in the 1980s and early 1990s, this was by design – a trade-off (between current income for future income via superannuation) to drive investment and growth in the economy.

From the mid-1990s, keeping a lid on wages became more an industrial instrument or individual bargaining matter, with the public sector taking a lead to keep wages growth low and capped.

Three things have happened over the last few decades.

First, over the last few decades, we have seen policy drive a rise in the profit share at the expense of employee compensation.

The idea of this was to build the capacity for greater investment which would then pay dividends for the economy in terms of productivity, jobs, and wages.

The reality is far from this.

The profit share went up, but instead of driving investment, it went to shareholders, both domestic and foreign.

Reserve Bank governor, Philip Lowe, noted the other week that while there were a number of overseas factors affecting inflation, there were domestic ones too. Picture: Getty Images

While the profit share rose from just over 10 per cent of GDP 20 years ago to around 24 per cent, investment as a share of GDP has been sub-optimal, and languished in recent years.

Indeed, as the Reserve Bank charts released recently show, investment in the economy is currently just over 10 per cent of GDP, down from a recent peak of around 18 per cent in the period after the GFC.

If we exclude mining, business investment as a share of the economy is now down to 8.2 per cent.

It is why economists bang on so much about the need for economic reforms. If you engineer a rise in the profit share, then competition, regulation and incentives should drive a return to the economy through greater dynamism, investment, innovation, and ultimately jobs and wages.

Second, we are starting to see the emergence of a disconnect ­between real wages and productivity. In many respects this is due to the first explanation above, but it’s also because the power of unions has dwindled through reduced union density and decentralised employment agreements.

In addition, as Rod Sims has noted recently, there’s a link ­between high industry concentration, a lack of competitive pressure and lower wages in Australia.

As this disconnect is emerging, people are rightly asking whether they are getting their fair share.

Third, we have witnessed a decade or more of real wage growth that has been low or even negative. Inflation erodes your purchasing power and if real wages growth is negative, it means that making ends meet is nigh on impossible.

So it is not surprising that we have sleepwalked into a debate about inequality, unfairness, and a crisis of being unable attract or retain workers in key sectors such as aged care.

Which all leads to the question of how can we afford higher wages so people can make ends meet, without entering a spiral of wage rises, leading to higher inflation, leading to higher interest rates, leading to it being harder to make ends meet.

The answer is in economic ­reform.

The Reserve Bank governor, Dr Philip Lowe, noted the other week that while there were a number of overseas factors affecting inflation, there were domestic ones too.

The bottom line is that we have neglected reforms for too long and not driven our economy to invest in the things that drive productivity and growth.

Investment in Australia needs a big boost – this means we need reforms to drive incentives and long-overdue attention to competition and regulation to ensure that economic rents aren’t just pocketed by shareholders.

In fact, Australia’s poor ­performance on productivity can be accounted for by a sub-optimal amount of investment in the ­economy.

It’s time business and government came to the table on this. It’s a shared responsibility to kickstart investment and drive dynamism in the economy through innovation and skills.

Without this, we will keep shouting at each other instead of working together co-operatively on the basics of economic growth to satisfy our collective goals and ambition.

Cathryn Lee is a director at Deloitte Access Economics. Pradeep Philip is head of Deloitte Access Economics.