Despite the fixation of many global central banks with the perils of deflation, there appear to be important supply-side dynamics taking place across the global economy which suggest either low inflation can co-exist with reasonable output and employment growth, or that inflation is set to take off and further help from central banks may not be required.
Either way we currently face the following conundrum: despite apparently tight labour markets across the developed world, wage inflation has refused to budge.
Let’s call it the curious case of the wage that did not rise.
In an insightful speech on March 8, Reserve Bank of Australia Deputy Governor Phillip Lowe made an interesting observation: across many countries, it appears to be the case that “the low wage increases have coexisted with fairly strong employment growth and not-so-strong output growth”.
As seen in the chart below, across the US, Japan, Germany and the UK, “employment growth has been quite strong relative to historical trends, but output growth has not. It is also worth noting that each of these four countries is at, or near, conventional estimates of full employment.”
Yes you read that right: full employment!
Lowe offered several suggestion why this might be the case. One possibility is that workers have less bargaining power (likely to due to globalisation and technology), and so are having to accept relatively low wage gains. In turn, that is encouraging relatively strong employment growth (typically in low productivity service sectors) due to the cheapness of labour.
Another theory for the phenomena is that it’s the structural change in economic growth toward services that is driving the relative strength in employment.
Under either of these scenarios, however, it would suggest rising wage growth is merely a question of time. After all, relative strength in employment and tightening labour markets (despite below average economic growth) does suggest worker bargaining power in developed economies must be improving.
In this regard, the recent lift in US wage growth (at a time when the unemployment rate is only 4.9%) could be a portent of things to come.
But if wage growth fails to rise all that much – despite apparent full employment conditions in many countries – it naturally begs the question: why?
One obvious explanation is that what we thought of as full employment needs to be adjusted: maybe developed economies can cope with much lower rates of unemployment than we give them credit for. If so, then we’re currently enjoying a supply-side revolution (which also helped explain low inflation) and central banks should sit back and relax.
Alternately, if unemployment fails to drop further and wage growth still fails to budge, what then? What if wage inflation stays low but businesses complain they can’t find any workers?
We should at least conclude the demand side stimulus measures from central banks have done their job: we can’t and should not ask for more, especially if negative interest rates and quantitative easing are potentially creating medium-term financial stability risks.
Indeed, if wages fail to rise despite labour shortages, then what we’re likely facing is a fully globalised market in labour, goods and services: firms can’t simply bid up local wages growth because they can’t simply put up their prices (which are set on world markets) to cover the cost.
Again low inflation in this regard does not reflect deficient demand but global competition – which has been healthy in that it has effectively lower the cost of labour to the extent that quite low level of unemployment have been achieved in many markets.
So far so good: why then are central bank still printing money and buying up debt when they don’t need to?
