No honeymoon for Chalmers as clouds gather on horizon

New Treasurer Jim Chalmers. Picture: AFP

On the face of it, the lowest unemployment rate in nearly 50 years looks like a good starting point for the incoming Labor government.

At 3.9 per cent last month – it turned out that it was also 3.9 per cent in March after revision – the labour market is brimming with job opportunities for workers and frustration for employers facing staff shortages. The rate of underemployment – workers wanting to work more hours – also fell to a low level.

Bear in mind that today’s unemployment rate is a much better figure than in 1974. The labour force participation rate is a great deal higher – at least six percentage points – and women make up nearly half of the workforce. Let’s face it, women got a bad deal in the labour force five decades ago.

Having said this, there won’t be much time for the Labor government to celebrate, in part because unemployment is a lagging indicator and the low rate is only a partial indicator of the economic challenges ahead.

One of the conundrums has been the weak effect that low and falling unemployment has had on wage growth. On the basis of the past relationship between unemployment and wage growth, we would expect annual wage growth to be in the range of 3 to 4 per cent. The latest figure for the wage price index indicated annual growth of 2.4 per cent.

Had inflation remained low, the wages figure would not necessarily be a problem. But the latest release of the consumer price index showed inflation running at more than 5 per cent, implying that real wages are going backwards. (Even on the basis of the cost-of-living index for employees released by the Australian Bureau of Statistics, real wages are falling, although to a lesser degree.)

While recorded inflation in Australia is slightly lower than overseas – the latest number for the US was more than 8 per cent and for Britain it was 9 per cent – at 5 per cent it is uncomfortably high for the Reserve Bank. It is clear the cash rate will be adjusted upwards several times this year, although the endpoint in this cycle is unclear. These increases will flow on to higher mortgage rates as well as higher rates for business loans. The rates still will be low by historical standards but the increases will have a dampening impact on the economy and will hit recent mortgage holders in particular.

There are also clouds on the economic horizon in terms of what is happening in many countries. The prospect of inflation rising further, including via the effect of higher energy costs and potential wage-price spirals, has governments and central banks rifling through the economic manual for courses of action. Having endured two years of pandemic restrictions, even with government assis­tance, the public in many countries is irritated by slow wage growth and rising cost of living. The fact there are no easy solutions for governments points to persistent and possibly rising grumpiness on the part of voters and consumers.

In one sense Australia is better placed than many countries because of its abundance of commodities in strong demand, in part because of Russia’s invasion of Ukraine. The March budget contained pessimistic assumptions about movements in the price of iron ore and coal that already look wildly inaccurate.

According to Treasury, “key commodity prices are assumed to decline from current elevated levels by the end of the September quarter 2022”. So Treasury’s thinking was that in less than six months iron ore would be trading at $US55 a tonne; metallurgical coal would be down to $US130 a tonne and thermal coal would be $60 a tonne.

Precipitous declines of this magnitude were extremely unlikely. Those commodities are currently trading at two to three times those prices. In effect, we as a country are being awarded a pay rise by virtue of higher commodity prices, which is leading to higher government revenue (and royalty income for states).

Treasury’s forecasting ability also can be called into question when it comes to its inflation estimates. According to the budget, the guess for this year is 4.25 per cent, followed by 3 per cent next financial year and 2.75 per cent in 2023-24. These numbers look too low at this stage.

In a related guess is the assumption used by Treasury that the huge government debt can be serviced at 2.2 per cent. The long-term government bond rate is already higher than this figure. Labor will need to grapple with potentially rising annual costs of the debt and pay attention to means of adding as little as possible to this liability. It would be preferable for the government to start to pay off the debt.

Attention will have to turn to means of repairing the budget to relieve monetary policy of some of the heavy lifting to contain inflationary pressures. Neither of the major parties showed any inclination during the campaign to begin fiscal consolidation, with Labor foreshadowing more spending in several areas, including childcare and aged care.

Another challenging area will be rising energy costs – a feature of several countries, made worse by the Russian situation. Recent increases here in wholesale electricity prices – a near annual doubling in some states – mean rises in retail prices will start to affect households and businesses in the second half of the year.

New Treasurer Jim Chalmers will have little time for contemplation before he is required to meet the economic challenges that are emerging. The new government may need to reconsider some of the pledges made during the campaign lest the short-term damage offset any benefits.

The narrative the parties used during the election – that the economy is travelling well after the challenges of the pandemic and the future looks rosy – was always too simplistic. There may be some good news but the list of challenges is long and pressing.

Inflation, cost-of-living pressures, rising energy costs, falling housing affordability – these will require the attention of our politicians. And let’s not forget the deteriorating national security environment. The low rate of unemployment may not last long; it didn’t in 1974. By all means, we should celebrate the achievement, but there is no time like the present to deal with the long list of challenges while acknowledging that government actions can make things worse.