Employment weakness…is not dutch disease

June 14, 2011

FOREX, RBA and Interest Rates

I do not, as a rule, like to attack other writers or commentators directly as almost 25 years of doing this has taught me to be humble before the markets and my own hubris. Readers know I do have cause for berating the punditocracy but today I must take direct issue with an article I saw in Business Spectator over the weekend.  

The article looked at the break up of the recent weakness in employment and made the case that it is not Dutch Disease driving it – which it clearly isn’t. [EDIT: Greg here – a couple of readers have just pinged me and said this doesn’t make sense. So what I actually meant was that he’d thrown up a straw man to make an argument but missed the whole point. I don’t mean that rudely as you’ll see below.] But let me start with the conclusion and then explain where I disagree on the analysis. The writer, Rob Burgess, says (my emphasis),

The charts above seem to cut the economic pie at 90 degrees to the line sketched out by commentators, including myself, that have favoured the Dutch disease explanation in the past couple of years. We’ll know more as clearer jobs trends emerge, and business failures should be watched carefully.

Please forgive me, but the trend is already evident as you can see in the chart below,

Have a look at the light blue line, it’s the month on month trend growth in employment. If that is not a trend then I don’t know what is. I would refer readers to my blog from last Thursday when the weak employment data came out for a recap on what’s going on and how obvious this trend has been for some months. This chart above which also has retail sales and house prices on it, together with the NAB employment index continues to suggest further employment weakness.

We’d argue that employment weakness is about a weak domestic economy and lower demand, and we have done for some time.

But there is part of our argument that I don’t think we have ever articulated that relates directly to why we think the RBA is over-tightening and to the speed limit of the economy but also helps explain what Burgess is saying (see quote further below).

RBA Governor Steven’s gave a speech in September 2008 titled The Directors Cut: Four Important Long-run Themes”where one of the themes he addressed was the difference between trying to get to an economy at full employment and dealing with an economy that is essentially at full employment. He said (my bolding and red for emphasis), 

But the economics of full employment are different from the economics of trying to get to full employment. This is a simple point, but an important one. When the economy has too much spare capacity – say, in the aftermath of a business cycle downturn – the aim of macroeconomic policies is to push up demand so that it catches up to supply potential. There may be several years in which demand growth exceeds the normal pace as it eats into the spare capacity.

Once the spare capacity has been wound in, however, actual growth in demand and output has to slow, to match the growth rate of potential supply. That growth in potential supply is given by the growth in the labour force, the capital stock and the productivity of those factors of production. Typically we think of ‘potential GDP’ in Australia rising by something like 3 per cent a year, give or take a bit.

This, as my predecessor Ian Macfarlane remarked a few years ago, means that once the reserves of spare capacity are pretty much used up, we should expect to be accustomed to growth rates for GDP starting with a 2 or a 3. There will not be many with 4s or 5s, as we had for some years through the 1990s and earlier this decade. Periods of growth noticeably above about 3 per cent will be roughly matched in frequency and duration by periods below – as we are having now. If we set our aspirations higher than that – if we try for above-average performance all the time – we will just get inflation. That is the economics of full employment.

Now you may feel that a growth rate for real GDP of something like 3 per cent on average is not that high. Is that the best we can do? Can’t we lift it?

The only way the potential growth rate can be lifted is by adding more factors of production – more labour and capital – or raising the growth rate of productivity. Over the long-term, the key is productivity. On that front, productivity growth does seem over the past several years to have settled at a lower average rate than we had seen since the early 1990s. This may have several causes, and the experts debate them. But over the years ahead, as a community we must be sure not to let up on our efforts to keep productivity growing. I have no specific policy prescriptions here – only general ones – trying to sustain competition, to keep markets open, to maintain flexibility and so on. But those general values are worth recounting from time to time.

So with an economy at or near full employment there is a natural handbrake on growth that flows from the ability of the economy to generate the jobs necessary to service demand and or productivity improvements. Burgess notes this when he says

After seeing the jobs data, I spoke with Peter Gleeson, executive general manager for recruitment at workforce consultants Chandler McLeod. He sees the data as being consistent with two kinds of skills shortages in Australia.

Firstly, the WA mining boom is providing an insatiable demand for fly-in fly-out workers. His firm is supplying workers as fast as it can, but many jobs go unfilled producing wages across the board “50 per cent higher than commercial rates elsewhere”.

So not only are there inflationary pressures building in regions such as the Pilbara, but thousand of jobs that should be created fail to find appropriate workers — were the labour market not so tight, jobs growth in WA would be faster.

The pattern is less clear in Queensland, says Gleeson, mainly because of the huge labour market upheaval caused by last summer’s floods and cyclones. He expects the market to stabilise into a pattern closer to WA’s, but says the data is ‘flaky’ at the moment.

The second skills shortage is producing more interesting results. In the non-resources-related sectors, particularly in the south-east, Gleeson is seeing a spike in part-time work. He see this as a “try before you buy” mentality, reflecting that fact that businesses are taking on underqualified staff in the hope that they’ll be good enough to fill a permanent or full-time role.

Importantly, he sees this trend as separate to the increase in the prevalence of contracting in areas such as IT, accounting, engineering and administration.

While all of these skills areas have used contractors for years, Gleeson says his firm is placing burgeoning numbers of workers for take-home pay that is 40 per cent higher on average than similar staff roles – that’s after statutory requirements such as superannuation and insurance have been paid.

Overall, then, jobs growth is being hampered in the resource states by a lack of labour, both skilled and unskilled, and jobs growth in the non-resources areas is being slowed by a lack of qualified staff, leading employers to ‘experiment’ with part-time or temporary workers to see if they have what it takes to fill the jobs anyway.

Again, the argument is convincing.

If we think about what Governor Stevens said above we can see that this is happening as a result of the natural speed limits he was talking about. Indeed this is the classic example of what Steven’s was talking about – the Australian economy is bumping against a speed limit with the available population. It’s why the RBA is so watchful of a potential uptick in inflation – and even though we think they shouldn’t be rushing to hike they are right to remain vigilant.

So to us the positive impact of the boom must be naturally tempered where the boom relies on the addition of employees who are at the lower end of the productivity curve. Thus for us, knowing there is a speed limit, knowing not everyone wants to work in the Pilbara for a sustained time and knowing that Households are under intense debt burden pressure speaks to us of an Economy already slower than it appears at face value and at risk of the RBA over-tightening. Certainly we know that mining will need to become more productive but for now it’s not. So the hand brake is real and underappreciated we think.

The Australian economy is clearly at risk of dutch disease as weak economies elsewhere and the mining boom continue to support the AUD such that it looks like it is going to average in the 90’s for a while rather than the mid 70’s since the float. This is yet to hit.

The true cause of weak employment is a weakening domestic economy and capacity constraints. Unfortunately as the NAB Business survey employment index told us again today this combination also suggests further weakness to come.



This blog is for information only and does not constitute advice. Neither Greg McKenna nor Lighthouse Securities has taken your personal circumstances, objectives or financial situation into account. Because of this you should, before acting on this information, consider its appropriateness, having regard to your objectives, financial situation or needs.

If you do need economic, investment or financial adviser we are happy to help and if you are an adviser and would like to join our network we are also happy to help.

Please Email the team at Lighthouse at info@lighthousesecurities.com.au or Greg directly on greg@lighthousesecurities.com.au

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