On wages: expectations and reality

Last week, when I was tied up with other stuff, I heard a few media reports that a new Westpac survey was showing that public expectations of wage increases were slipping away.  At the time, I didn’t look at the details, but made a note to come back to it.

This was the key chart included in Westpac’s report of the survey results.

wage expectations

Introduced with this text:

Although workers may be feeling more confident about job opportunities, when it comes to the outlook for earnings, sentiment is really in the dumps. Increasing numbers of workers are telling us that they don’t expect any change in their earnings from work over the coming year. In fact, the number of workers who expect to receive a pay increase over the coming year is languishing at the sort of lows we saw during the financial crisis.

Concluding with this

And while nominal wage growth has remained muted, consumer price inflation has picked up. After lingering below 1% for much of the past few years, consumer price
inflation is now running at 1.7% per annum. This means that the limited pay rises many workers have received have only just been keeping pace with changes in the cost of living. And for those workers who didn’t receive a pay rise (and even for some that did), their spending power may be going backwards.

I’m not really convinced.

I’m not doubting that respondents did answer the question the way Westpac reports. I wouldn’t even be surprised if the recent reversal of wage expectations was the real thing: there was all sorts of talk not long away about wage inflation being just about to “take off”, which so far hasn’t come to anything much.   But even with the recent reversal, expectations are still just back to around where they were for a fair part of 2015 and 2016.

My concern is more about how to interpret the longer-run of data in the chart and, in fact, how to make sense of wage data themselves.

For a start, surely respondents to this survey are inclined to bias their answers downwards?  After all, look at the results for the 2005 to 2007 period, when the labour market was unquestionably tight (including the fact that the unemployment rate was below 4 per cent), and general wage inflation –  on any of the measures –  was quite high.  And yet only around 50 per cent of respondents expected a wage increase.  Many more than that must have been achieving a wage increase.  As I’ve noted previously, the labour share of total income has actually been increasing in New Zealand.

Second, it is worth remembering that inflation expectations now are materially lower than they were a decade ago.

household expecs 2017

The numbers bounce around a bit, but at the end of the previous boom the average year-ahead expectation was around 4.5 per cent, whereas now it around 3 per cent.  (One shouldn’t put much weight on the absolute numbers, but the pattern is consistent with others surveys of inflation expectations.)   If inflation expectations have fallen materially, surely it is reasonable that fewer survey respondents will now be expecting nominal wage increases, even if everything else (labour market tightness, productivity growth or whatever) was unchanged?

Westpac also uses as a reference point a 1.7 per cent rise in annual wages.  That number appears to come from the LCI, a series that purports to adjust for what firms’ report were productivity changes.  It is better to use the “analytical unadjusted” measure from the LCI, which is closer to a stratified raw measure of wage increases –  which is, after all, more like what the respondents in the Westpac survey are being asked about.

Many commentator also focus on the even lower wage inflation numbers from the Quarterly Employment Survey (QES) –  a wage measure that is notoriously volatile (and not really representative of how anyone thinks the labour market is actually working).  It is quite prone to compositional changes, and thus doesn’t reflect – or really try to reflect –  an individual’s own experience in the labour market.

I’ve covered this issue in an earlier post.

I’m not sure why people put so much weight on the QES measure of hourly wage inflation.  It has well-known problems (for these purposes) and is hugely volatile.   Here is a chart showing wage inflation for the private sector according to (a) the QES, and (b) the Labour Cost Index, analytical unadjusted series.

wages debate  No economic analyst thinks wage inflation is anything like as volatile as the blue line –  in fact, wage stickiness, and persistence in wage-setting patterns is one of the features of modern market economies.

And here is the chart I ran last week, comparing real private sector wage inflation (the orange line above, adjusted for the sectoral core measure of CPI inflation) with productivity growth.

Real wage inflation now is lower than it was in the pre-2008 boom years, but it is running well ahead of productivity growth (however one lags or transforms it).

As I noted in that earlier post, real wage inflation in New Zealand has been surprisingly strong in recent years, given the complete absence of any (actual or trend) growth in labour productivity (real GDP per hour worked).  Of course, low inflation and low inflation expectations hold down the nominal rates of wage increases (relative to what we were experiencing a decade ago), but the real measures are largely what matter.   Real household purchasing power from labour income in New Zealand has been increasing –  from increased employment, but also from real wage increases that are more than it is likely that the economy can support in the longer-term.

Perhaps then people are right to expect more modest wage increases ahead.  But if so, it will likely be because the non-tradables led pseudo-boom of the last few years comes to an end, and market processes across the economy force an adjustment in wage-setting to something more consistent with our alarmingly poor productivity growth record (in this particular bad phase now five years and counting).

 

19 thoughts on “On wages: expectations and reality

  1. I remember the days when wages were pegged to inflation and were adjusted automatically, just like government employees from the prime minister down, are today. Why them and not us anymore?

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  2. Sorry, not on message but I would be interested in your comments on ‘quantatitive easing’ -use and results – as practised in UK, USA, Japan given Winston Peters’ occasional suggestion that NZ could employ such a device/s. An article or two??

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    • Interesting question. As it happens I’m in the midst of writing a review article on a book that touches on just those issues, so I might turn some of that into a post. My potted version is “QE mostly hasn’t been very important since the dark days of intense crisis in 08/09”.

      I hadn’t heard that Winston was favouring QE. The Greens (Russel Norman) used to, but it was mostly a daft ill-thought-through suggestions. MOstly other countries used QE because interest rates got as low as they could do, or they were in the midst of severe crisis. We are not in either state, and have never had our policy interest rates approach zero.

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  3. “If inflation expectations have fallen materially, surely it is reasonable that fewer survey respondents will now be expecting nominal wage increases, even if everything else (labour market tightness, productivity growth or whatever) was unchanged?”

    If an RBNZ economist asks me two questions, “What do you expect inflation to be in the next 12 months”, and “Do you expect a pay rise in the next 12 months?”, I would probably not connect those questions at all. For the first question, I would probably not have any information except the prices of stuff on the shelves I noticed recently. “I think milk went up last week, so inflation must be on the rise, Imma say 4%!” For the second question, I’d consider my specific situation, like whether the firm is doing well (productivity growth) as reported to me by my boss, or whether I’m on track for a promotion.

    I think if everything else (labour market tightness, productivity growth) was unchanged, as a respondent I would not infer from inflation that I’d get a payrise. And I’d like to think I’m a comparatively high-information respondent. They’re tracking the general public, right? Many respondents couldn’t tell you what a “CPI” is or tell you whether it includes the rent and some probably couldn’t define “inflation” at all.

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    • Fair points, but nonetheless in the aggregate and over time there are still likely to be the sorts of implicit effects I suggest. When inflation was 15% pa, almost everyone expected and got an annual wage increase. WIth zero inflation, they wouldn’t.

      In the RB survey of inflation they do find quite a lot of respondents who can’t give them a number, so the reported numbers are at best indicative. But surveys of economists also show a substantial reduction in expected inflation over the last decade (as do market prices – the difference between normal and inflation indexed bonds).

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  4. I’m a huge fan of your blog Michael, thanks very much

    Question on the stats: Is it possible that the non-labour share of income is understated because it is not declared? And perhaps becoming less & less declared?

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    • It is possible but (a) one would have wonder why that suddenly became more of a problem 15 years ago, when the NZ labour share started rising again, and (b) at present the wages data – see my chart comparing real wage rates and productivity growth – seems consistent with what one would expect if the labour share was holding up or rising.

      Our problem is lack of productivity growth, not that labour is doing badly given the atrocious productivity.

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    • Probably some mix of misperceptions and (more importantly) the fact that the shock is non-tradables driven, There has been a significant domestic-sourced increase in the demand for labour. Tradables sector get increasingly squeezed out (the increase in real unit labour costs is an increase in the real exchange rate).

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    • Service based businesses do not look at productivity as a measure. Also most of the multinational companies in NZ are branch sales and customer service orientated and also would not be overly concerned with productivity as a measure of success. eg Cadbury used to have manufacturing in NZ but that has been shut down but will continue as a Cadbury theme park for tourists providing customer sales and entertainment and to showcase products.

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      • Fisher and Paykell used to have huge manufacturing that was productivity driven but that has been shut down and turned into a research center with Intergroup cost recovery as a revenue stream and subsequently stacked with research engineers and research assistants and a pool of administrators with patents as the primary measure of success rather than sales productivity measures.

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      • the issue isn’t whether indiv firms look at productivity. over time, it is that over time across the whole economy only growth in productivity supports sustainable growth in wages. Individual firms pay what they have to pay to get the people they need, and if they can’t afford that price they other need to either change production structures, or – at the limit- shutdown.

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  5. Michael
    A query and a comment.
    Why do you use changes in per capita GDP as a proxy for productivity?
    There are lots of factors which push GDP about which have nothing to do with productivity.
    Given that Wages – GDP/Capita reflects (amongst other things) the share of GDP going to labour, presumably real wages can grow faster than GDP/Capita for quite some time if capital providers accept less of the pie?
    Perhaps in a low yield world the capital providers are happy with less?
    If this is correct, it also helps explain the US data that shows corporates share of the pie rising and wages flat-lining.
    Tim

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    • Tim

      My proxy for labour productivity is real GDP per hour worked – which is a pretty standard approach internationally. I wasn’t clear in the labelling in the extract I lifted into this post.

      Terms of trade gains do explain a bit of the gap between real wage growth and real productivity growth, but not all of it by any means.

      Re low yields etc, yes I agree that is a plausible story , but actually as the chart in this post shows in the typical OECD country there hasn’t been a change in the labour share in the last 15 years
      https://croakingcassandra.com/2017/08/30/labour-share-of-income/ NZ has had one of the larger increases, and in many countries the labour share has been falling even as interest rates reached record lows.

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  6. That survey is real not many people in the last 4 years in bank middle management have had a decent bonus or pay increase, these people are supposedly skilled. I remember the introduction of private contracts some 20 years back was meant to lead to better pay outcomes for the hard workers instead it became a tool to divide and conquer and means to extract longer worker hours. All this benefit has gone to the corporate profit margin wage increases have been below labour productivity for some time me awhile CEO pay keeps expanding despite their subpar performance relative to the expectations they place on staff. Meanwhile CEOs have boosted profits by heavily under investing in their businesses. Thus capital productivity has been low.

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    • If you are generating a higher revenue with under investment in capital. That would equate to higher return to capital invested which equates to higher capital productivity??

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      • Thats how accountant’s calculate capital productivity which can be misleading in the short-term but is very reliable long-term ie. if there constantly investing at rates below depreciation. Economists use a measure which is closer to revenue in their formula = the amount of output produced by a unit of capital
        an increase in capital productivity means that a unit of capital is producing more output than in the previous year, or that the same amount of amount is being produced for fewer capital inputs.

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  7. NZFundManager – Some CEO / worker pay ratios in NZ

    1997 = 11.8
    2002 = 15.2
    2010 = 21.9
    2011 = 22.5

    http://www.stuff.co.nz/business/money/7366296/Growing-pay-gap-between-CEOs-staff
    “But it is less clear why pay multiples should appear to trend upwards. According to a PhD study by Helen Roberts of Otago University, who tracked listed company pay rates from 1997 to 2002, the average chief executive’s pay grew from 11.8 times the national worker average to 15.2 times over the period, in real terms.”
    “In BusinessDay’s second annual survey of pay rates in top listed companies, we found CEOs were paid an average 22.5 times more than their employees in the 2011 financial year, up from 21.9 times a year earlier” (2010).

    One would presume this trend is occurring in NZ due to a more deregulated market since 1984 and we are part of a more and more globalised society so NZ follows international trends in these pay ratios.

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