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Sluggish economy's chicken-and-egg problem

AAP logoAAP 11/08/2016 Garry Shilson-Josling, Economist

The sluggish economy is causing slow wages growth - but slow wages growth is causing the economy to stay sluggish.

The chicken-and-egg problem is bedevilling policymakers, but they aren't talking about it much.

On Wednesday, Glenn Stevens gave his final speech as RBA governor, a wide-ranging review of the past decade and the problems facing the economy.

He did it without once mentioning wages or household income.

But perhaps they warranted a little attention.

Last year, the ordinary time earnings of the average adult full-time worker in the private sector fell by nearly one per cent compared to the consumer price index.

This measure of real wages had previously fallen, albeit marginally, in 2004, as a delayed effect of the spike in unemployment caused by the global recession and stock market meltdown of 2000-2001.

But the last time wages had posted a significant real-terms decline was in 1992, as the labour market was being strangled by the economy's last recession.

So the wage outcomes workers are currently suffering are what would normally be seen right after a serious economic slump.

And that has consequences.

Just last week, the Australian Bureau of Statistics released data showing the trend in retail spending was barely half the pace seen this time last year.

A few economists acknowledged the role played by wages.

They included St George Bank senior economist Hans Kunnen, who said he was not expecting retail sales figures to "shoot out the lights" in the near term.

"Support from higher wages seems unlikely anytime soon," he said.

But it's more common for economists to mention wages growth in two different contexts.

The first is as a reason the unemployment is not even higher, because employers are less inclined to retrench cheaper workers, an argument stressed repeatedly by the RBA.

The other is as an explanation for slow consumer price inflation, either through the direct effect of softer demand on retail price markups or because it means slower growth in labour costs feeding into prices.

But a third, and arguably more important, effect is that wages growth drives spending, which in turn drives business investment and employment.

And it's a vicious circle.

For wages growth to pick up, businesses first have to hire more workers and drive the unemployment rate down, forcing employers to offer more to attract the right people.

But weak household spending, thanks to soft wages growth , is a major reason why they are not.

It's the Catch-22 problem that's underpinning the lacklustre economic outlook.

And the effect of weak wages growth is being reinforced by two other ingredients making up household income - an ongoing decline in hours worked by the average employee, and plodding growth in the numbers employed.

It's why annual rises in real household disposable income averaged only 1.9 per cent over the past five years - less than half the pace of the preceding decade and the slowest five-year growth since the early-1990s recession.

And it's why the RBA could say last week, without any dissent from private sector economists, that unemployment "will move only a little lower" over the coming two and half years.

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