Wage rises to fuel inflation and economic trauma

Treasury secretary Dr Steven Kennedy briefing Treasurer Jim Chalmers.

The decision last week by the Fair Work Commission to increase award wages by 5.75 per cent for more than 2.5 million workers has all but guaranteed further interest rate rises. In turn, this will put more pressure on many mortgage holders as well as renters. Businesses will be hit from a number of directions: higher wages, higher debt servicing costs, ongoing inflation and weaker demand.

So where is the economy heading? Is there still a real prospect of Australia navigating the narrow path to lower inflation while maintaining very low rates of unemployment? Is it really acceptable to wait until 2025 until inflation achieves a desirable rate within the 2 to 3 per cent band?

Consider first how the Reserve Bank is likely to respond to the generosity of the FWC. (A higher increase of 8.6 per cent was awarded to the small number of workers who receive the national minimum wage. Given that there are relatively few of them, this aspect of the decision is unlikely to be seen as material by the bank.) The real problem is that, absent any improvement to productivity, the increase in award wages will, at best, lock in inflation at its currently unacceptably high rate. Note here that the superannuation guarantee rate also increases by half a percentage point on July 1.

The lesson from the 1970s and ’80s was that allowing wages to chase high rates of inflation is a self-defeating exercise. Real wages don’t rise and there is a very real risk of prompting a sharp contraction in economic activity. Were it not for our high commodity prices and the (unfortunate) surge in the migrant intake, the Australian economy could already be in trouble.

Bragging about Australia’s superior GDP growth performance against other major economies, as Prime Minister Anthony Albanese did last week, completely ignores the role played by rapid population growth on absolute GDP growth. In per capita terms, Australia’s recent performance, as well as its performance over the past decade or so, has been dismal.

One of the chief problems at the moment is that monetary policy is being called on to do all the heavy lifting when it comes to bringing down the rate of inflation. Notwithstanding the assertion of Treasurer Jim Chalmers, and weakly defended by Treasury secretary Steven Kennedy, that the budget handed down last month is also contractionary, the figures tell a different story. Government payments jump from 24.8 per cent of GDP this financial year to 26.5 per cent in 2023-24. The underlying fiscal balance goes from a surplus of 0.2 per cent of GDP to a deficit of 0.5 per cent next financial year.

It’s simply not possible to square these figures with the depiction of the budget as anti-inflationary. And bear in mind this government has embarked on a raft of off-budget spending – think here Rewiring the Nation and the National Reconstruction Fund, in particular – which only shows up in the headline budget balance figure. The spending is nonetheless adding to demand pressures in the economy.

Two of the key drivers of the high rate of inflation at the moment are energy prices and rents. Notwithstanding the assurances of the government that greater penetration of renewable energy in the electricity grid will lead to lower prices, the evidence to date has pointed to the reverse. With the closure of the Liddell coal-fired plant and the delayed reopening of the Callide plant in Queensland, wholesale electricity prices have been trending upwards.

The rollout of the energy rebates early in the new financial year will offset, at least in part, rising energy prices as a component of the CPI. But further rises in energy prices are still possible, which would, best-case scenario, have the effect of delaying the return to an acceptable rate of inflation.

Rising rents are also likely to remain a key driver of higher prices for some time. The combination of influences is particularly toxic, with demand soaring and additions to supply stalled for a variety of reasons.

Yet the government shows no indication it intends to slow the rate of immigration even though there are levers that could be pulled should it wish to do so. The UK is showing the way by restricting the scope for international students to bring accompanying family members to those undertaking PhD degrees.

In the meantime, builders are going broke and the estimated number of additional dwellings needed far exceeds the likely increase in supply. Measures by state governments that favour tenants simply deter investment in residential housing. Victoria’s recent decision to increase the incidence and rate of property tax for investors – it is estimated an additional $4.7bn will be raised over four years – will ensure the rental situation in that state remains particularly dire for some time.

The argument by some progressive commentators that increasing the cash rate by the RBA is self-defeating because higher interest rates feed into higher rents, which feed into a higher CPI, is wrongheaded. The cash rate is essentially the only instrument the bank has and its analysis of inflationary trends looks through these effects.

The broader point is that these same progressive commentators, in reality, do not support focused inflation targeting by the bank and would prefer there be no further increases to the cash rate or, preferably, some cuts. The argument goes that by implementing a series of measures, including through budgetary assistance and high minimum wage rises, those at the bottom of the income distribution can be protected from the negative effects of inflation.

For this reason, they support the equal weighting of inflation and unemployment as the rule the RBA should now follow, a recommendation that was lobbed in at the final moment in the recently released review of the Reserve Bank of Australia, An RBA fit for the Future.

Arguably, a combination of inflation around 6 per cent and unemployment at 3.5 per cent would be seen as justification for no further changes to the cash rate.

The reality, however, is that inflation is a vicious form of tax that will cut a swath through the middle class. It already is, as real incomes are cut, mortgage payments rise and bracket creep takes effect. For this reason alone, it’s not clear why the governor of the RBA thinks it is acceptable to wait until 2025 until inflation is (possibly) brought back under control.

If it is so evil, it’s better to get inflation back to an acceptable band much more quickly. Had the government done the right thing in the budget, there may have been a chance. As for those members of the FWC who think being generous has no downsides, they need to take a crash course in economics before they hand down their next decision. At this stage, it looks as though we are in for some difficult economic times.