Treasury warns on jobless figure needed to fuel wage rises

It could take an unemployment rate with a 3 in front of it before the labour market tightens sufficiently to restore healthy growth to wages, a new Treasury study says.

Treasurer Josh Frydenberg arrives to address the Australian Chamber of Commerce and Industry at Parliament House in Canberra. Picture: AAP

It could take an unemployment rate with a 3 in front of it before the labour market tightens sufficiently to restore healthy growth to wages, according to a new study by Treasury.

In a paper seeking to estimate the Non-Accelerating Inflation Rate of Unemployment, which reflects the degree of slack in the jobs market, Treasury economists conclude that the NAIRU is between 4.5 and 5 per cent over the past few years immediately prior to the COVID-19 recession. But that could be too high because of structural changes brought about by the pandemic and global forces.

“Persistently high levels of underemployment, a reduced willingness by workers to bargain for wage increases, or a reduction in inflation expectations could all mean that the unemployment rate must be lower before wage pressures materialise,” they write.

“These factors will be influenced by the strength and duration of the recovery”.

The research was cited by Josh Frydenberg in a speech on Thursday, in which he revealed an updated fiscal strategy ahead of the May 11 budget. “This lower estimate of the NAIRU means a lower unemployment rate will now be required to see inflation and wages accelerate,” the Treasurer told the Australian Chamber of Commerce and Industry.

“In effect, both the RBA and Treasury’s best estimate is that the unemployment rate will now need to have a 4 in front of it to deliver this outcome.”

Mr Frydenberg is preparing the ground for a spending blitz to cut unemployment below 5 per cent, while delaying budget repair.

In explaining how the NAIRU could drift lower, Treasury says higher levels of underemployment could mean there is a greater degree of labour market slack than captured by measures such as the Phillips curve, which shows an inverse relationship between inflation and unemployment.

“Additionally, structural factors may have altered the wage and price setting dynamics in advanced economies,” the economists write. “These include increased competition in good markets, increases in services being provided internationally, advances in technology, and changes in the supply of labour and labour market regulation”.

But estimating the NAIRU is fraught, given it can’t actually be observed. Treasury notes the variable could be higher because of the crisis and ageing. Labour market “scarring” effects, such as poor initial-worker matching and the atrophying of skills in the long-term unemployed, could be in play.

“Labour market scarring would mean that the pool of workers with suitable skills is actually smaller at a given unemployment rate, which would mean wage pressures might materialise at a higher level of unemployment,” they write.

“The recovery from the COVID-19 shock has so far been much quicker than anticipated, so there could be fewer scarring ­effects than previously expected, which would boost labour market spare capacity.”

As well, global trends such as ageing populations could lower savings rates and increase pressure on inflation and wages.

In another paper released on Thursday, Treasury observed long-term changes in labour participation. In a projection, Linus Gustafsson found that by 2060, women aged 45-54 will see the biggest shift in participation. From about 80 per cent now, the cohort’s participation will rise to 90 per cent, equalling the rate of males.

Opposition Treasury spokesman Jim Chalmers said he agreed with the policy goal of driving ­unemployment below 5 per cent but said the Morrison government did not have the right plan.

“It was not that long ago that this Treasurer said his unemployment target was just under 6 per cent, and now he has been forced to say it is something more like 4.5 per cent,” Dr Chalmers said.

“This is an admission that, up until now, the Treasurer has got his budget strategy wrong.”