Digging out the truth: why the case for increasing wages is flawed

The fall in labour’s income share can be attributed entirely to mining, where commodity prices have increased faster than wages. AAP/Energy Resources Australia

New research shows workers are taking home a smaller portion of income in the economy now than at the beginning of the last decade. Some would like to see increased wages to restore that share - despite this putting even more pressure on struggling sectors like manufacturing.

But labour did not, in fact, miss out. The true picture is hidden by surging commodity prices and there is not a case to raise wages to restore the labour income share.

High income growth in the 1990s saw labour’s share of income from the production of goods and services remain stable. But this is no longer the case. That share fell by at least 4% in the last decade. And capital’s share - the gross income that businesses receive as a return on their investments - rose to the same degree.

At first glance, this fall raises concern that workers may have missed out on its usual “fair” share of income gains. But research compiled for the Productivity Commission highlights the unusual circumstances that mean the fall in labour’s share is not what it first seems.

The last decade was a very prosperous decade. Wages and returns on investments both grew more rapidly than they did in the previous decade. On the labour side, there was faster growth in both employment and wages. The labour income share only fell because growth in capital income sped up more than growth in labour income did.

But the ACTU considers the falls in Australia’s labour share to be “a worrying development”.

It correctly associated the fall with labour productivity outpacing real wages. And it’s advocating an increase in real wage rates to restore labour’s share.

It’s in the terms of trade

Normally when we examine real wage trends, we see how far nominal wages have risen relative to inflation in consumer prices. If we get a 4% nominal wage rise, but consumer prices rise 1.5%, the real value of the wage rate has increased 2.5%.

The real value of wages considered in this usual way did keep pace with productivity growth. In fact, they exceeded labour productivity growth from around 2002-03.

What the ACTU is referring to is something else. They compare growth in wages to inflation in the prices of the goods and services produced in Australia. This real wage captures the real cost of labour to producers – how fast wages rise relative to the sales prices they achieve.

In the last ten years, the prices of things Australia produces rose much faster than the prices of goods and services that Australians consume. And so, the real cost of labour rose a lot less than the real value of wages as income.

That’s why growth in the real cost of labour did not keep pace with growth in labour productivity, but growth in real income wages exceeded it.

The disparity between product prices and consumer prices was unusual and was the result of the large lift in Australia’s terms of trade – the ratio of export prices to import prices. Higher commodity prices raised export and product prices and the high exchange rate lowered import and consumer prices.

Australia’s terms of trade increased dramatically between 2004 and 2009. Australian Bureau of Statistics, 2007–08 = 100.0.

It was the miners

The fall in the labour income share can be attributed almost entirely to the mining boom. The massive increases in commodity prices actually reduced the real cost of labour in mining, even though there was strong growth in nominal wages.

In fact, the real cost of labour declined so much that the mining industry alone accounted for all of the gap between growth in real wages (as a cost) and labour productivity growth. The fall in labour income share was not a general phenomenon. It was specific to mining.

Some industries, including construction and manufacturing, actually increased the labour income share.

So the claim that labour has missed out on its fair share of the income gains does not stack up. There is not a case to raise wages to restore the labour income share.

If additional wage rises were granted, it would add to cost pressures on industries, such as manufacturing, already facing difficult adjustments.

The real cost of labour is going to increase in any case, not because of higher nominal wage growth, but because commodity prices have started to fall. Any additional nominal wage growth would raise the danger that real labour costs will rise faster than labour productivity growth.

Strong wage growth can only be supported by strong labour productivity growth.

As the terms of trade decline, real income growth will be impacted, and Australians will not enjoy the same rate of improvement in prosperity that they have enjoyed over the past two decades. Unless there is a return to very strong productivity growth. That should be our focus.