Why is it that over the past several months financial analysts and pundits seem to have been convinced that the Reserve Bank would increase interest rates? There were even reports analysts were running a betting ring, with 100 per cent predicting a rise. Wrong so far. Interest rates are steady.
How could Australia's allegedly best financial brains be so wrong?
It's easy to understand. Financial analysts generally predict the future by reading statistical tea leaves of the past. They look at trend lines going back decades and assume (reasonably) that where a trend has been repeated often enough it's destined to repeat itself in the future.
Analysts have been looking at collapsing unemployment, which in May reached a three-decade low of 4.2 per cent. Over the past 50 years, when unemployment drops, wages increase, creating wage-induced inflation. Central banks' traditional response is to increase interest rates to cool the economy and keep unemployment at non-inflationary levels. (It seems that pools of unemployed have been necessary to ensure economic stability. Pity the unemployed!)
Financial analysts have been caught out. Trend lines of the past have been broken. Unemployment has headed south to a degree not thought possible five years ago. At the same time, wage-induced inflation is absent. Why?
In early June, Reserve Bank governor Glenn Stevens gave the first official indication. He said that data on labour costs indicate that inflation should stay within acceptable limits. This was contrary to Reserve expectations of a year ago. He speculated that at least part of the explanation had to do with "changed behaviour in the labour market". He observed that wages were increasing quickly in some sectors of the economy but slowly in others. Overall, relative wages were increasing within the capacity of the economy to cope. He said it had the appearance of a "text-book case of adjustment".
He said that this was due to changes in the way the labour market functioned, including increases in participation rates and rises in immigration. He did not speculate on the politically sensitive area of changes to workplace relations laws. It would be imprudent for a Reserve governor to comment on such matters. But it would probably be foolish of financial analysts to ignore the central impact of the changes to workplace laws in containing wage-induced inflation. The victory over wage-induced inflation is no accident.
For five decades a centrally controlled wages system pushed wage increases in one sector through to all sectors regardless of capacity to pay. Traditionally, wages under the metals award would be adjusted upwards and passed on to all awards by administrative decrees of industrial relations commissions.
In the past decade this process has been driven more by industry pattern bargaining than award alterations. Wage increases in one company would flow via enterprise agreements to other companies in the same sector, then onto other sectors.
The process was driven by a theoretical belief that wage "justice" was guaranteed by maintaining percentage differentials between industries and job classifications, administered by quasi-legal commissions. But that system did not take into account whether individual businesses could pay. Businesses unable to pay had to increase prices, creating the dynamic for inflation.
The more recent reforms to Australia's labour laws have neutered the system that secured this particular notion of wages justice. A core conservative Australian value for 100 years has been ditched.
It's been replaced by a system guaranteeing minimum pay rates, but beyond the minimums, the system allows each business to pay according to capacity.
Flow-on effect is now mostly market driven. Hence, we witness huge pay increases in the mining sector but only modest ones in the rural and retail sectors.
For financial analysts this is a new environment; trends of the past can't predict the future. Interest rate speculation has become more difficult. It requires a detailed understanding of the micro operations of labour markets.
Risks exist. Could the new system contain inflation if unemployment dropped to 2 or 3 per cent? Who knows. But it's fair to speculate that a return to a traditional system of administering wages justice would reintroduce wage-induced inflation.
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