Wages, earnings capacity and all that

There has been a line run in many quarters over recent years suggesting that wage inflation is surprisingly low.   There was a bit of that tone in several articles on such issues in the Sunday Star-Times yesterday, and it even appeared in the Leader of the Opposition’s speech last week

For many New Zealanders, incomes are struggling to keep up with the rising cost of living.

We’ll probably see more such stories when the next round of labour market statistics are released later this week.

As I’ve noted in various posts over a couple of years now (including recently), I’m not at all convinced by this story.

My preferrred measure of wage inflation is the Statistics New Zealand analytical unadjusted Labour Cost Index series.  The LCI is designed to be stratified –  comparing wage inflation for the same jobs (and so not facing the compositional issues the QES measures have) –  and the “analytical unadjusted” refers to the idea that these are straight wage measures, not ones that attempt to adjust for individual job productivity changes (as the headline LCI numbers do).  The series is only available back to the 1990s, but here is the history.

LCI 1

Nominal wage inflation has picked up a little, but is still well below what people got used to in the five years or so prior to the last recession.  But so is inflation for goods and services.

Here is the same wage series adjusted for the Reserve Bank’s sectoral factor model measure of core inflation (I could have used the headline CPI –  the averages don’t change materially, but there is a lot more “noise” in the CPI itself).

LCI 2

Two things caught my eye:

  • first, each and every year real wages (on aggregate across the economy) have risen –  even in the depths of the last recession.   It won’t have been (and won’t be) true for every individual, but it is true –  at least on these measures (generated by our national statistics agency, and the official agency best placed to tell us about core inflation) –  across the economy as a whole.
  • second, real wage inflation this decade looks to have averaged not materially different to what we experienced in the late 1990s and 00s.  There were individual years where faster wage inflation was recorded, but if there is a systematic weakness in real wage increases  this decade compared to what went before, the difference is pretty small.   And notwithstanding talk –  in those SST articles –  that the current labour market is “as good it gets” actually the unemployment rate is still above the lows of the 00s.

All of which is a little strange, because economywide productivity growth has slumped (to basically zero in recent years).  Here is a chart of estimated labour productivity back to 1995 when the LCI series starts. I’ve shown it in logs, so that a less steeply rising line accurately illustrates a declining growth rate of productivity.

lci 3

There is a bit of short-term noise in the series, but the key story is pretty easily visible: growth in labour productivity has been slowing, mostly recently to nothing.   All else equal, it should be a bit surprising if there are persistent gains in economywide real wages when there is little or no productivity growth.

Of course, the other consideration that affects economywide potential is the terms of trade. If the terms of trade increase then even if there is no growth in real labour productivity, the overall pot is bigger and –  all else equal –  it is likely that over time wages will rise to some extent to reflect that improvement.  It is a mechanical process, or a certain one, and there is a variety of possible channels, but in an economy that experiences considerable terms of trade variability it isn’t a factor that can simply be overlooked.

I’ve attempted to take account of the terms of trade in this chart, which I ran in post last month.

lci wages vs gdp

This chart compares how wages have been rising relative to the increase in nominal GDP per hour worked (the latter measure including both productivity and terms of trade effects).   A rising line –  as New Zealand has experienced (on these data) this century –  suggests that wages have been rising at a faster rate than the earnings potential of the economy.      That difference –  perhaps 13 percentage points over 17 years –  adds up to something quite significant.  On its own –  taken in isolation –  it is neither something necessarily good nor something necessarily bad.   There are distributional changes in any economy over time.  But it is something that could not continue at the same rate indefinitely (this isn’t a statement of ideology or sophisticated economic argumentation,  but simply a matter of basic arithmetic).

Here is another way to look at the issue. The chart shows the OECD’s relative unit labour cost measure of New Zealand’s real exchange rate, in this case back to 1980.

rer to end 18

I’ve broken into two the period since liberalisation in 1984.  In both periods –  although especially the earlier one –  there has been plenty of variability in the real exchange rate.  But the average in the second half of the period has been far higher than in the first half.  Since standard theory tells us to have expected exchange rate overshoots temporarily as part of getting inflation down, I could quite legitimately have focused simply on, say, the 10 years after 1991 and compared them to the more recent period.  My point is not that any single point of comparison is somehow the “right” one, simply that in an economy where productivity growth has lagged behind that in most of the rest of the advanced world, there is something anomalous about a real exchange rate as high as ours have been.  Since this is a unit labour cost measure, it fits nicely with the previous chart –  wages and salaries have been rising faster than the economy’s earnings capacity, and to a greater extent than in many other countries.   Consistent with all that, our firms (as a whole) haven’t been able to successfully increase their penetration of world markets (export shares have been flat or falling).

Not this is in any sense the fault of wage-earners, or indeed of individual firms, all of whom are mostly responding to the incentives the economy has thrown up, and how policy has tilted the playing field.  This decade, some of those things were unavoidable (the earthquakes) but others were pure, deeply misguided, public policy choices.   Rapid population growth generates lots of activity and demand for labour but –  at least in New Zealand’s case –  appears to have done nothing to improve the longer-term earnings capacity of the economy.

In the end, material living standards in any economy will largely reflect productivity growth.  And yet, somewhat weirdly –  but perhaps consistent with the increasing political cone of silence around that failure –  as far as I could see not one of the SST articles yesterday even mentioned the productivity failure as the biggest obstacle to sustainably higher wages and material living standards.    For now, we’ve been in a bit of a fool’s paradise –  wages appear to have been growing faster than economic capacity.  But unless something serious is done to reverse the productivity failure, it is hard to see that real wage inflation in the next decade will be able to be as high as it has been this decade.  The bigger question right now shouldn’t be why wage inflation is so low, but why it is still so high.

(None of this is to rule out the possibility of some problems with the analytical unadjusted LCI data, but (a) SNZ has not pointed users to serious problems, and (b) the picture I’m painting doesn’t seem inconsistent with either the labour share of GDP data or the real exchange rate measures.)

 

 

How are wage earners doing?

For the last few years –  probably almost since the economy began emerging from the long recession of 2008 to 2010 –  there has been talk about how low average wage increases have been.   Those lines have sometimes been run in discussions of the general rate of inflation –  all else equal, if inflation had been nearer target, average nominal wage increases probably would have been a bit higher –  but more often it seems to have been a real phenomenon people had in mind; some sense of wage earners being “left behind”.

I’ve been increasingly sceptical of that story, and did a few posts  12-18 months ago to illustrate the point.   Some of the data aren’t updated very often, and there are historical data revisions, so I thought it might be time to take another look.

The first series I’ve been interested in is the labour share of GDP –  as approximated by the share of all the value-added in the economy accruing as compensation of employees. To make this comparison, one needs to adjust out for taxes and subsidies on production (all else equal, a shift from income taxes to a higher GST won’t raise wages –  or leave people worse off on average – but will raise measured GDP).  The data are only available annually, and only up to the March 2018 year, but here is the resulting chart.

labour share 2018

There is a little bit of short-term variability in the series, but if (say) one compares the latest observation (year to March 2018) with the last observation before the recession (year to March 2008), the labour share of GDP is still a touch higher now than it was then.  In both cases, it was higher than it had been at any time in the previous fifteen years or so.   As I’ve noted previously, the trough was in the year to March 2002 (on my telling, this was not unrelated to the fact that the real exchange rate had then been around historic lows).

The other comparison I find interesting is to look at how wage rates have evolved relative to (nominal) GDP per hour worked.   Nominal GDP captures both any productivity gains the economy has managed and any terms of trade gains (as well as general inflation).  Over the longer-term one would expect those variables to be the biggest influence on developments in economywide wages.

In putting together this chart, I’ve used the SNZ analytical unadjusted series of the Labour Cost Index, which purports to be the right measure for these purposes (wage rates, rather than just average wages –  the latter distorted by composition changes, and wages before any adjustments for productivity –  the headline LCI series attempts to adjust for productivity gains).    The series doesn’t get wide coverage but –  absent any serious efforts to suggest the data are of unusually poor quality –  should.

Unfortunately, the analytical unadjusted LCI series is only available back to 1995 (the private sector sub-component only to 1998) but even that is now well over 20 years of data.

In the chart I have:

  • indexed nominal (seasonally adjusted) GDP per hour worked (using the HLFS and QES), and
  • indexed the analytical unadjusted LCI series,

both to 100 in the March quarter of 1995, and then taken the ratio of the wage series to the GDP per hour worked series (so that the resulting series is equal to 1 in the March quarter of 1995).

lci wages vs gdp

There is a fair bit of short-term noise, but the trend is pretty clear.  On this data, wages have been rising faster than the overall earnings capacity of the economy.   That was so in the 00s, and has been so –  albeit to a lesser extent – in recent years too.  For anyone inclined to want to debunk the analytical unadjusted series, note that this chart is not wildly inconsistent with the labour share chart I showed earlier: the labour share of total income has increased since the early 00s, with the biggest change occurring in the pre-recession 00s themselves.

So what is the problem?  There are two.  First, general economywide inflation has been unexpectedly low this decade, and below the target midpoint now for years.   Not surprisingly, against that backdrop nominal wage inflation has been lower than it might otherwise have been.

But the second –  and far bigger –  issue is that lack of productivity growth.   Here is my regular chart, last updated just before Christmas

real GDP phw dec 18

There has been no labour productivity growth for the last four years, and very little this decade.  Sure, the terms of trade have been reasonably good, but you cannot expect strong sustained growth in (real) wages if productivity growth is so moribund.   If anything, real wage growth has been surprisingly – and probably unsustainably –  strong given that feeble growth in the earnings capacity of the economy.    It is all consistent with a story of a high and overvalued real exchange rate  –  domestic demand pressures give rise to wage inflation, but in the process squeeze the outward-facing sectors of our economy.  You’ll recall that exports (and imports) peaked as a share of GDP at about the turn of the century, and are no higher now than they were 40 years ago –  even though successful small economies typically see a growing reliance on two-way international trade.

It would be good if our political “leaders” –  and their advisers in The Treasury –  actually focused on these sorts of imbalances and underperformances.  But nothing serious is heard any longer from the Prime Minister about the productivity underperformance.  Taking it seriously might confront them with hard choices, and I guess vapid rhetoric about “wellbeing Budgets” comes more readily.  New Zealanders –  including New Zealand wage earners –  deserve much better.

 

Consumption, investment and wages (inflation) in New Zealand

After writing yesterday’s post, I noticed another somewhat-confused article on the “low wage” question.  The author of that piece seemed to want to look at after-tax wages, without then looking at the services those taxes might deliver.   Taxes are (much) higher in France or Denmark, but so is the range of government services.

One way of looking at the material standard of living question is to look at per capita consumption, again converted using PPP exchange rates.   Just looking at private consumption –  the things you and I purchase directly –  will also skew comparisons.    Take two hypothetical countries with the same real GDP per capita.  One has much lower taxes than the other, but health and education in that country are totally private responsibilities,  whereas in the higher tax country many of those services are delivered by the government, largely free to the user at the point of use.    Private consumption in the low-tax country will be much higher than in the high-tax country, but the overall actual consumption of goods and services may not be much different  (depending on incentive effects etc, a topic for another day).

For cross-country comparisons, the way to handle these differences is to use estimate of actual individual consumption: private consumption plus the bits of government consumption spending consumed directly by households (eg health and education).  Separate again is “collective consumption” –  things like defence spending, or the cost of central government policy advice, which have no direct or immediate consumption benefit to households.

Here is the data for the OECD countries for 2016, where the average across the whole of the OECD is 100.

AIC 2016

New Zealand does a little less badly on this measure than on the various income or productivity measures.  That is consistent with the fact that our savings rates tend to be lower than those in many other OECD countries and (relative to productivity measures) to high average working hours per capita.  On this measure in all the former communist countries now in the OECD the average person still consumes much less than the average New Zealander does.  Unlike many advanced economies, we have consistently run current account deficits.   Large current account surpluses –  Netherlands for example has surpluses of around 10 per cent of GDP –  open up the possibility of rather higher future consumption.

Having dug into the data this far, I decided to have a look at investment spending per capita.  I mostly focus on investment as a share of GDP, and have repeatedly highlighted here the OECD comparisons that show business investment as a share of GDP has been relatively low in New Zealand for decades, even though we’ve had relatively rapid population growth (and thus, all else equal, needed more investment just to maintain the existing capital stock per worker).   Here is the OECD data, for total gross fixed capital formation (“investment” in national accounts terms) and ex-housing (where there are a few gaps in the data).

investment ppp

You can probably ignore the numbers for Ireland (distorted by various international tax issues) and Luxembourg (lots of investment supports workers who commute from neighbouring countries).  But however you look at it, New Zealand shows up in the middle of the pack.  That mightn’t look too bad –  and, actually, was a bit higher than I expected to find – but when considering investment one always needs to take account of population growth rates.      Average investment spending per capita might be similar to that in France, Finland, or Germany, but over the most recent five years, the populations of those countries increased by around 2 per cent, while New Zealand’s population increased by 9 per cent.  Just to keep up, all else equal, we’d have needed much more investment spending (average per capita) than in those other countries.

Over the most recent five years, only two OECD countries had faster rates of population growth than New Zealand.  One was Luxembourg –  where, as far as we can tell, things look fine (lots of investment, lots of consumption, high wages, high productivity) –  and the other was Israel.  In Israel, average investment spending (total or ex-housing) was even lower than in New Zealand.  And as I highlighted in a post a few months ago, Israel’s productivity record has been strikingly poor.

But how has Israel done by comparison?  This chart just shows the ratio of real GDP per hour worked for New Zealand and Israel relative to that of the United States (as a representative high productivity OECD economy), starting from 1981 because that is when the Israel data starts.

israel nz comparison

We’ve done badly, and they’ve done even worse.

If productivity growth is the basis for sustained growth in material living standards –  and employee compensation –  how have wages been doing recently in New Zealand?

One way of looking at the question is to compare the growth in GDP per hour worked with the growth in wages.  If we look at nominal GDP per hour worked, we capture terms of trade effects (which can boost living standards without real productivity gains) and avoid the need to choose a deflator.  From the wages side, I still like to use the SNZ analytical unadjusted labour cost index series.  Perhaps there are serious flaws in it –  if so, SNZ should tell us – but, on paper, it looks like the best wage rates series we have.

Here is the resulting chart, with everything indexed to 1 in 1998q3, when the private sector LCI analytical unadjusted series begins.

NGDP and wages

When the series is rising, wages (as measured by this series) have risen faster than the average hourly value of what is produced in New Zealand.  A chart like this says nothing about the absolute level of wages (or indeed of GDP per hour worked), but it does suggests that over the last 15 years or so, wage rates in New Zealand have been rising faster than the value of what is produced in New Zealand.  That is broadly consistent with the rebound in the labour share of total GDP over that period.  There is some noise in the data, so not much should be made of any specific shorter-term comparisons, but even over the last five years –  when there has been so much public angst about wages – it looks as though wage inflation has outstripped hourly growth in nominal GDP (even amid a strong terms of trade).    All of which is consistent with my story of a persistently (and, so I argue, unsustainably) out-of-line real exchange rate, notably over the last 15 years or so.

New Zealand is a low wage, low productivty (advanced) country.  We don’t seem to do quite as badly when it comes to consumption, but investment remains quite low (relative to the needs of rapidly growing population) and wage earners have been seeing their earnings increase faster than the (pretty poor) growth in GDP per hour worked.  None of that is a good basis for optimism about future economic prospects, unless politicians and officials finally embrace an alternative approach, under which we might see faster (per capita) capital stock growth and stronger productivity growth, in turn laying the foundations for sustainably higher earnings (and higher consumption).  Most likely, a key component of any such approach would involve finally abandoning the “big(ger) New Zealand” mythology that has (mis)guided our leaders –  and misled our people – for decades.

A low wage, low productivity (advanced) economy

There was an article on Stuff the other day from Kirk Hope, head of Business New Zealand, suggesting (in the headline no less) that “the idea [New Zealand] is a ‘low-wage economy’ is a myth”.   I didn’t even bother opening the article, so little credence have I come to give to almost anything published under Hope’s name (when there is merit is his argument, the case is almost invariably over-egged or reliant on questionable numbers).   But a few people asked about it, including a resident young economics student, so I finally decided to take a look.

Hope attempts to build his argument on OECD wages data.   I guess it is a reasonable place to try to start, but he doesn’t really appear to understand the data, or their limitations, including that (as the notes to the OECD tables explicitly state) the New Zealand numbers are calculated differently than those of most other countries in the tables.

The reported data are estimated full-time equivalent average annual wages, calculated thus:

This dataset contains data on average annual wages per full-time and full-year equivalent employee in the total economy.  Average annual wages per full-time equivalent dependent employee are obtained by dividing the national-accounts-based total wage bill by the average number of employees in the total economy, which is then multiplied by the ratio of average usual weekly hours per full-time employee to average usually weekly hours for all employees.

That seems fine as far as it goes, subject to the limitation that in a country where people work longer hours then, all else equal, average annual wages will be higher.  Personally, I’d have preferred a comparison of average hourly wage rates (which must be possible to calculate from the source data mentioned here) but the OECD don’t report that series  (and I don’t really expect Hope or his staff to have derived it themselves).   Although New Zealand has, by OECD standards, high hours worked per capita, we don’t have unusually high hours worked per employee (the reconciliation being that our participation rate is higher than average) so this particular point probably doesn’t materially affect cross-country comparisons.

The OECD reports the estimated average annual wages data in various forms.   National currency data obviously isn’t any use for cross-country comparisons, so the focus here (and in Hope’s article) is on the data converted into USD, for which there are two series.  The first is simply converted at market exchange rates, while the second is converted at estimated purchasing power parity (PPP) exchange rates.   Use of PPP exchange rates –  with all their inevitable imprecisions –  is the standard approach to doing cross-country comparisons.

Decades ago people realised that simply doing conversions at market exchange rates could be quite misleading.   One reason is that market exchange rate fluctuate quite a lot, and when a country’s exchange rate is high, any value expressed in the currency of that country when converted into (say) USD will also appear high.  Take wages for example: a 20 per cent increase in the exchange rate will result in a 20 per cent increase in the USD value of New Zealand wages, but New Zealanders won’t be anything like that amount better off.  The same goes for, say, GDP comparisons.   That is why analysts typically focus on comparisons done using PPP exchange rates.

But not Mr Hope.   Using the simple market exchange rate comparisons, he argues

OECD analysis however shows that NZ is not a low-wage economy. We sit in 16th place out of 35 countries in terms of average wages.

(Actually, I count 14th.  And recall that it isn’t many decades since we were in the top 2 or 3 of these sort of league tables.)

But he does then turn to the PPP measures, without really appearing to understand PPP measures.

But the OECD analysis also shows that among those countries our relative Purchasing Power Parity (PPP), a measure of how much of a given item can be purchased by each country’s average wage, is lower.

New Zealand is included among a group of countries – Australia, Denmark, Iceland, Norway, Sweden, Switzerland and the UK – where wages don’t buy as much as they could.

That’s right: Australia – where the grass has always been deemed to be greener, and Switzerland – which has long been lauded for its quality of life.

There are several possible explanations for wages in this group being higher than their PPP.

The Nordic countries have high tax rates, which support their social infrastructure but dilute their spending power.

We have lower tax rates – but the costs of housing, as an obvious example, are a lot higher in PPP terms than in other countries.

In PPP terms, the estimated average annual wages of New Zealand workers, on these OECD numbers, was 19th out of 35 countries.   The OECD has expanded its membership a lot in recent decades –  to bring in various emerging economies, especially in eastern Europe (the former communist ones).  But of the western European and North American OECD economies (the bit of the OECD we used to mainly compare ourselves against), only Spain, Italy, and (perpetual laggard) Portugal score lower than New Zealand.  On this measure.

But to revert to Hope’s analysis, he appears to think there is something wrong or anomalous about wages in PPP terms being lower than those in market exchange rate terms.  But that simply isn’t so.  In fact, it is what one expects for very high income and very productive countries, even when market exchange rates aren’t out of line.   In highly productive economies, the costs of non-tradables tend to be high, and in very poor countries those costs tend to be low (barbers in Suva earn a lot less than those in Zurich, but do much the same job).     Poor countries tend to have PPP measures of GDP or wages above those calculated at market exchange rates, and rich countries tend to have the reverse.  It isn’t a commentary on policy, just a reflection of the underlying economics.

Tax rates and structures of social spending also have nothing to do with these sorts of comparisons.  They might be relevant to comparisons across countries of disposable incomes, or even of consumption, but that isn’t what Hope is setting out to compare.

But he is right –  inadvertently –  to highlight the anomaly that in New Zealand, PPP measures are below those calculated on market exchange rates.  That seems to be a reflection of two things: first, a persistently overvalued real exchange rate (a long-running theme of this blog), and second, the sense that New Zealand is a pretty high cost economy, perhaps (as some have argued) because of the limited amount of competition in many services sectors.

But there is a more serious problem with Hope’s comparisons, one that presumably he didn’t notice when he had the numbers done.   I spotted this note on the OECD table.

Recommended uses and limitations
Real compensation per employee (instead of real wages) are considered for Chile, Iceland, Mexico and New Zealand.

Wages and compensation can be two quite different things.   If so, the comparisons across most OECD countries won’t be a problem, but any that involve comparing Chile, Iceland, Mexico or New Zealand with any of the other OECD countries could be quite severely impaired.   In many respects, using total compensation of employees seems a better basis for comparisons that whatever is labelled as “wages” –  since, for example, tax structures and other legislative mandates affect the prevalence of fringe benefits – but it isn’t very meaningful to compare wages in one country with total compensation in another.

Does the difference matter?  Well, I went to the OECD database and downloaded the data for total compensation of employees and total wages and salaries.  In the median OECD country for which there is data for both series, compensation is about 22 per cent higher than wages and salaries.     I’m not 100 per cent sure how the respective series are calculated, but those numbers didn’t really surprise me.   Almost inevitably, total compensation has to be equal to or greater than wages.   (There is an anomaly however in respect of the New Zealand numbers.  Of those countries where compensation is used, New Zealand is the only one for which the OECD also reports wages and salaries.  The data say that wages and salaries are higher than compensation –  an apparently nonsensical results, which is presumably why the OECD chose to use the compensation numbers.)

So what do the numbers look like if we actually do an apples for apples comparison, using total compensation of employees data for each country.  Here I’ve approximated this by scaling up the numbers for the countries where the OECD used wages data by the ratio of total compensation to total wages in each country (rather than doing the source calculations directly).

compensation per employee

On this measure, New Zealand comes 24th in the OECD, with the usual bunch behind us – perpetual failures like Portugal and Mexico on the one hand, and the rapidly emerging former communist countries on the other.  On this estimate (imprecise) Slovenia is now very slightly above New Zealand.  By advanced country standards, we are now a low wage (low total employee compensation) country.

But it is about what one would expect given New Zealand low ranking productivity performance.   Here is a chart showing the relationship between the derived annual compensation per (FTE) employee (as per the previous chart) and OECD data on real GDP per hour worked for 2016 (the most recent year for which there is complete data).  Both are expressed in USD by PPP terms.

compensation and productivity

Frankly, it is a bit closer relationship than I expected (especially given that one variable is an annual measure and one an hourly measure).  There are a few outliers to the right of the chart: Ireland (where the corporate tax rules resulted in an inflated real GDP), Luxembourg, and Norway (where the decision by the state to directly save much of the proceeds from the oil wealth probably means wages are lower than they otherwise would be).    For those with sharp eyesight, I’ve marked the New Zealand observation in red: we don’t appear to be an outlier on this measure at all.  Employee compensation appears to be about what one would expect given our dire long-term productivity performance.

And that appears to be the point on which –  unusually –  Kirk Hope and I are at one.  He ends his article this way

We need to first do the hard yards on improving productivity, and then push for sustainable growth in wages.

If we don’t fix the decades-long productivity failure, we can’t expect to systematically be earning more.  Sadly, there is no sign that either the government or the National Party has any serious intention of fixing that failure, or any ideas as to how it might be done.

Incidentally, this sort of analysis –  suggesting that employee compensation in New Zealand is about where one might expect given overall economywide productivity –  also runs directly counter to the curious argument advanced in Matthew Hooton’s Herald column the other day, in which he argued that wages were being materially held down by the presence of Working for Families.   In addition, of course, were Hooton’s argument true then (all else equal) we’d should expect to see childless people and those without dependent children dropping out of the labour force (discouraged by the dismal returns to work available to those not getting the WFF top-up).   And yet, for example, labour force participation rates of the elderly in New Zealand –  very few of whom will be receiving WFF –  are among the highest in the OECD and have been rising.

And, of course, none of this is a comment on the merits, or otherwise, of any particular wage claim.

Workers in a fool’s paradise

A couple of months ago I did a post highlighting some little recognised aspects of the New Zealand data on wages and labour income.   They suggested that, given the underlying relatively poor performance of the economy, workers hadn’t done badly at all. I was curious how the latest national accounts data had changed the picture.

The first chart that attracted my interest was the labour income (“compensation of employees”) share of GDP.   The data are only available annually, but they suggested quite a recovery in the labour share of GDP in the 00s, which had been sustained this decade to date.

COE

That was the picture on the previous iteration of data.     Here is the updated version.

COE jan 17

The picture is subtly different, and if anything the labour income share looks to have been shrinking gradually this decade, even if it is still well above where it was in 2001/2 (the historical low).

But the other chart, which I found more striking, was one in which I compared growth in nominal wage rates against growth in nominal GDP per hour worked.   I used the Statistics New Zealand Analytical Unadjusted Labour Cost Index series.  It isn’t widely referred to, but relative to the headline LCI series it is a pure wages series, not one in which SNZ has already tried to adjust for productivity, and relative to the QES, it is much smoother (the way economists typically think of wage-setting behaviour) and produces more sensible and plausible series (some of the problems with the QES were illustrated in the earlier post).

When I did the exercise earlier, on the old data, I found that cumulative wage inflation –  particularly that in the private sector –  had run quite a bit ahead of productivity (GDP per hour worked) since around 2002.    Here is the updated version of the chart.

wages and nom GDP phw jan 18

There is a lot of short-term noise in the series –  and wages last year were somewhat “artificially” boosted by the pay equity settlement – but if the extent to which wages have moved ahead of productivity is less than it was in the previous iteration of the data (GDP has been revised up, and wage rate data are unchanged), the trend I highlighted last year is still there.

In my earlier post, I noted that this chart had been done using GDP itslf, and that to be more strictly accurate I should have taken account of, eg, the 2010 change in GST (which boosted GDP but shouldn’t have affected wages).    Data on indirect taxes and subsidies are only available annually, so here is a smoothed (four quarter moving average) version of the chart, this time comparing wages against nominal GDP per hour worked excluding indirect taxes and subsidies.

wages and nom GDP phw ex taxes and subsides jan 18

What has been going on?   One possibility is that the Analytical Unadjusted wages data are just substantially wrong?   But they are series that have now been published by SNZ for more than 20 years, and I don’t have specific things I can point to suggesting that they are wrong.

If the data are picking up something real, what then might be the story?   Here was what I included in the earlier post.

My explanation is pretty simple: the (real) exchange rate, which stepped up sharply about 15 years ago and has never sustainably come down since.    When the exchange rate is high, firms in the tradables sectors make less money than they otherwise would have done.   The usual counter to that is that the terms of trade have risen.  But the increase in the real exchange rate has been considerably more than the higher terms of trade would warrant, and in any case much of the gains in the terms of trade have come in the form of lower real import prices, rather than higher real export prices.

And why has the exchange rate been so high?  Because the economy has been strongly skewed towards the non-tradables sector which –  by definition –  does not face the test of international competition.  Demand for labour in that sector has been strong, on average, over the last 15 years, and it is the non-tradables sector that has, in effect, set the marginal price for labour.  For those firms, in aggregate, the lack of productivity growth doesn’t matter much –  they pass costs on to customers.  But it matters a lot for tradables sector producers, who have to pay the market price for labour, with no ability to pass those costs on (while the exchange rate puts downward pressure on their overall returns).  Another definition of the real exchange rate is the price of non-tradables relative to those of tradables. Consistent with this sort of story, in per capita terms real tradables sector GDP peaked back in 2004 (levels that is, not growth rates).

It isn’t, to repeat, a story in which labour has done well absolutely.  As I illustrated the other day, over the last five years there has been about 1 per cent real productivity growth in total.  For decades, we’ve been slipping backwards relative to other advanced countries.   But given the weak overall performance, labour doesn’t look to have done too badly.   That isn’t a recommendation for the “economic strategy” the last two governments have pursued.  A climate in which firms don’t find investment attractive –  perhaps especially investment in the internationally-competitive tradables sector –  isn’t likely to be one that conduces to generating sustained high performance and strong medium-term income growth.

And here is the proxy for business investment (total investment less housing and government) as a share of GDP

bus inv jan 18

Despite some of the best terms of trade in decades, business investment has been poor this cycle –  following on from several decades when it has typically been well below that of the median OECD country (despite well above median population growth).  The notion that “investment has been weak in lots of countries”, even to the extent true, should be no consolation: we started so far behind there was (and is) plenty of scope for us to have caught up, not being so affected by financial crises, euro-area ructions, zero lower bounds or whatever.

It is a fool’s paradise model: non-tradables focused businesses (of which there are many) do just fine, supported by continuing rapid population growth, but there isn’t much net investment at all outside those sectors as New Zealand proves to be an increasingly unfavourable place to build and base internationally competitive businesses.  Productivity growth remains weak, perhaps even weakens further.   Wages might well outstrip productivity growth, but in the long-run only sustained productivity growth will support high material living standards here.   It isn’t a model that need end in crisis, but rather in mediocrity.  And New Zealanders could do so much better.

 

Some labour market statistics that really should be looked into

There was a curious line in the Labour-New Zealand First agreement, under “Economy”.

Review the official measures for unemployment to ensure they accurately reflect the workforce of the 21st century.

I wasn’t (and still am not) clear what the two parties had in mind.  It got some people rather hot and bothered, with suggestions of political interference to get numbers that happened to suit the government of the day.  That interpretation seemed pretty far-fetched.  Plenty of people –  politicians included –  have views on what Statistics New Zealand should collect and report data on.  And governments have to decide what to fund Statistics New Zealand for –  regional nominal GDP data got added to the mix a while ago, there are now weird (and intrusive) things like the General Social Survey, and on the other hand we still don’t have monthly CPI data, monthly industrial production data (in both cases, unlike almost every other advanced country) or quarterly income-based measures of GDP.   Rather rashly, governments and SNZ appear on course to degrade our travel and immigration data.

So I don’t have a problem if parties to a government want to have a look again at some or other area of our official statistics, and perhaps even get Treasury and MBIE to commission some expert or other to have a fresh look at indicators of unemployment etc.  I’d be even more pleased if such a review led to the allocation of a bit more money to Statistics New Zealand.  But I’m not sure there is much of a problem with the HLFS as it is, even if my confidence in the data have taken a bit of a dip since my household has been in the survey (over the last few quarters).   Oh, and when they made changes to the HLFS last year, and made no attempt to backdate the new employment and hours series, simply leaving a level shift in the official series that was a bit trying too (one always has to remember to make a rough and ready adjustment for the break – I almost forgot to in the charts below).

Is it a bit odd and arbitrary that the headline measure of unemployment doesn’t count you as unemployed if you managed one hour’s paid work in the survey week, even if that was the only hour you managed to get all quarter and you’d really like a 40 hour a week job?    Absolutely it is.    But so long as the headline unemployment measures are used either for cross-country comparisons, or for comparisons within New Zealand over time, precisely where one draws that (inevitably) arbitrary line won’t matter very much.  Other countries also calculate headline unemployment rates that way, and we’ve been using the HLFS since 1986.

It is more of a problem when complacent commentators misuse the measure to go on about how “unemployment” is “only” 4.6 per cent, as if all is rosy.   Of course, even a 5 per cent “true” unemployment rate would mean that over a 40 year working life, the typical person would be unemployed –  on the quite narrow definition –  for two years.  That is a large chunk of time, and (like me) probably few of those commentators ever spent any time unemployed on this measure.

But SNZ does now do quite a reasonable job of providing a richer array of data that enables users –  and media and other commentators –  to get a fuller picture of overall supply/demand imbalances in the labour market.  We have data on the people in part-time work who would like to work more hours.  And data on people who would like a job but have become discouraged by repeated failure, and have given up searching (to the definitions of the HLFS).  Outside the HLFS we have data on those on welfare benefits.  Now there is even an official underutilisation rate, which can also be compared across time and (with more difficulty) across countries.   At 11.8 per cent that is a pretty high number, and probably one that –  were it more widely known –  would trouble many people (as it does me).   These numbers tend not to matter much to macroeconomic commentators, focused mostly on cyclical fluctuations, since the various different series tend to move together and a demand for long-term time series drives people quickly back to the headline measure.  But it doesn’t make the other measures less valuable or important for other purposes.

It is meaningless to say that “the” unemployment rate is 4.6 per cent, but that would have been as true in 1997 as it is 2017.  Then again, it probably isn’t meaningless to say that all the measures of excess labor supply are higher than they were 10 years ago, a period over which demographic trends have probably been working to lower the long-run sustainable rate of unemployment (on whichever measure you choose).

Statistics New Zealand don’t seem any better informed about the review

[Labour market manager] Ramsay said Statistics NZ had no more information about the review apart from what was in the coalition agreement.

“Nothing at this point. No content at all.”

But if there are resources to spend on reviewing and improving labour market statistics, I’d be making a bid for something around wages data.

A repeated theme from the Labour Party during the election campaign was that wage growth has been slow, and that this needed to change.  When the Labour Party leader was, at times, challenged about this claim, her response was that people didn’t “feel” better off.    Now, I’m sure perceptions matter a lot in politics, but ideally perceptions –  and the policies of governments – will be informed and shaped by the data, rather than the other way round.

In a post a few months ago I illustrated, using national accounts data, that the labour share of income has been trending up in New Zealand over the last 15 years or so.  COE

Over that period, on official data, New Zealand’s experience has been quite different from that of the other Anglo countries (and much of the commentary we read is British or American).  Across the OECD as a whole, the labour share in the median country hasn’t changed in the last 15 years, and New Zealand has had one of the larger increases. [UPDATE: An interesting illustration of how different the Australian experience has been.]

One of the problems in making sense of what is going on is that (a) we don’t have a quarterly income-based measure of GDP, so we fall back on the published wages data, and (b) the published wages data are all over the place.

Still most widely quoted is the very-volatile Quarterly Employment Survey measure of average hourly wage rates, a measure that (by construction) is subject to compositional changes  (if, this quarter, lots more low-skilled get jobs, even at good wage rates for those jobs, average hourly wage rates will fall even though no one is earning less per hour than they were).

Then there is the Labour Cost Index (LCI) which doesn’t purport to be a series of wage rates, but rather a proxy for unit labour costs. In other words, it is an attempt to measure wages adjusted for changes in productivity etc.  It is a smooth series, and is given prominence by SNZ, but it tells us nothing at all about the growth in the hourly earnings of the people who are in employment (adjusted for changes in composition).

And then there is the Analytical Unadjusted Index.  Even the name would deter most casual users.  It is found buried among the Labour Cost Index series, and  –  at least on paper –  looks like the best series we have.  It is constructed from the raw wages data SNZ collects to generate the headline LCI series, and is constructed in a stratifed way, to eliminate (or minimise) distortions arising from compositional changes.

This is what inflation in the Analytical Unadjusted series looks like

analytical unadj nov 17

It is relatively smooth –  conforming to economists’ priors about how labour markets work –  and, of course, (nominal) wage inflation is much lower it was a decade ago.  (Remember that the tick up in the most recent quarter is the impact of the pay-equity settlement.)    Of course, CPI inflation is also a lot lower than it was then.

A couple of months ago, I did a post using the Analytical Unadjusted data, deflating it by core inflation and comparing it with growth in real GDP per hour worked.  Real wage inflation appeared to have been running well ahead of productivity growth (the latter, non-existent, in aggregate, for the last five years).

But in that chart, I didn’t take account of the terms of trade.  A higher terms of trade – and New Zealand’s have done quite well in the last 15 years or so –  lifts the incomes the economy can afford to pay.  A better way to look at things might be to compare nominal wage growth with growth in nominal GDP per hour worked.  There is a lot of short-term variability in nominal GDP growth –  as dairy and oil prices ebb and flow  – but if we look at cumulative growth over fairly long periods we might hope to find something interesting.  Over very long periods of time we might expect hourly wage rates to increase at around the rate of growth in nominal GDP per hour worked.

The Analytical Unadjusted data go back to mid 1990s for the whole economy, and to the late 1990s for the private sector.   Here is what the resulting chart looks like.  Both series –  wage rates and nominal GDP per hour worked – are indexed to 100 when the Analytical Unadjusted data start.  (Recall that we still only have q2 GDP data).   I’m showing the ratio of the two series: when the line is rising, wage rates are rising faster than nominal GDP per hour worked.

wages and nomina GDP phw an unadj.png

For the first seven or eight years, the chart looks much as you’d expect.    There is quarter to quarter volatility in GDP, which is reflected in the ratio, but broadly wages were rising at around the rate of growth of  nominal GDP per hour worked.  Wages outstripped nominal GDP growth in the late boom years –  even as the terms of trade were rising –  and have done so again, in the last five years.   Over the last 15 years, private sector wage rates –  on this measure –  have risen perhaps 12 per cent faster than growth in the value of nominal GDP per hour worked.  (And the tax switch in 2010 will have boosted nominal GDP, without any reason to expect it would change pre-tax wage rates. so the “true” increases in wages relative to underlying GDP is even larger than the chart suggests).

I find this picture plausible, and I think I can tell a sensible story about what might have been going on.  But before I tell that story, here’s an alternative chart.    The QES wages data go back further, to 1989.  And here is what the chart of QES ordinary time wages rates looks like relative to growth in nominal GDP per hour worked back to 1989.

wages and nom GDP QES

It is on exactly the same scale as the previous chart.  But on this measure, private sector wages have barely kept pace with nominal GDP per hour worked growth over almost 30 years now (and have been losing ground since end of the 1990s), while public sector wage rates have outperformed (but almost all the out-performance was in the 1990s, under those spendthrifts, Ruth Richardson and Jenny Shipley.

I just don’t believe that the QES picture is portraying an accurate picture of what has been going on in the labour market.  For a start, it is inconsistent with the national accounts (the labour income share chart, which suggests that something turned in labour’s favour 15 years or so ago).  And the labour income share chart looks more consistent with the stratifed Analytical Unadjusted based measure.

To be clear, I’m not suggesting that labour has done particularly well.  The productivity performance of the New Zealand economy has been pretty lousy –  especially in the last five years –  and the unexpected (and outside our control) improvement in the terms of trade only offsets a bit of that gap.   Absolute levels of nominal GDP per hour worked in New Zealand remain very low by advanced country standards and, thus, so do wage rates.   But given the relatively poor performance of the economy as a whole, labour hasn’t done badly at all.  If people have feelings about these things it doesn’t look as though they should be about evil capitalists (or evil governments) rapaciously transferring money to themselves or their rich mates.  Simply that poorly performing economies –  with little or no productivity growth –  shouldn’t expect much wage inflation.  If there is rage, it should be about successive governments of both parties that have done nothing to redress that failure.

There might still be some serious problems with the statistics.  But if the Analytical Unadjusted series is roughly right (even if not many commentators cite it), how might one explain what it shows?  My explanation is pretty simple: the (real) exchange rate, which stepped up sharply about 15 years ago and has never sustainably come down since.    When the exchange rate is high, firms in the tradables sectors make less money than they otherwise would have done.   The usual counter to that is that the terms of trade have risen.  But the increase in the real exchange rate has been considerably more than the higher terms of trade would warrant, and in any case much of the gains in the terms of trade have come in the form of lower real import prices, rather than higher real export prices.

And why has the exchange rate been so high?  Because the economy has been strongly skewed towards the non-tradables sector which –  by definition –  does not face the test of international competition.  Demand for labour in that sector has been strong, on average, over the last 15 years, and it is the non-tradables sector that has, in effect, set the marginal price for labour.  For those firms, in aggregate, the lack of productivity growth doesn’t matter much –  they pass costs on to customers.  But it matters a lot for tradables sector producers, who have to pay the market price for labour, with no ability to pass those costs on (while the exchange rate puts downward pressure on their overall returns).  Another definition of the real exchange rate is the price of non-tradables relative to those of tradables. Consistent with this sort of story, in per capita terms real tradables sector GDP peaked back in 2004 (levels that is, not growth rates).

Perhaps it isn’t the correct story. Perhaps there is some serious problem with the data.  But if the government is serious about the words in the Speech from the Throne

A shift is required to create a more productive economy

one (small) step towards getting there might be set out to resolve the puzzles, and apparent inconsistencies, in our labour market (wages) data.  At present though, the best-constructed series suggests a badly-unbalanced economy.  Workers haven’t done badly given the poor performance of the overall economy, but the foundations haven’t been laid for durable real income growth –  if anything, they’ve been progressively whittled away as the foreign trade share of the economy has eroded.

 

 

 

 

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).