Feature Stories | Oct 25 2006
By Greg Peel
The new governor of the Reserve Bank of Australia has a problem. Glenn Stevens just can’t see how the numbers add up. Unemployment in Australia is as low as it’s ever been, but the Australian economy is sluggish compared to other world economies, and productivity has not improved since 2003.
Maybe the employment numbers are simply lagging. Maybe there will be an increase in Australian unemployment soon. Although growing tax receipts don’t back this up.
Maybe GDP growth and productivity are really higher than bureaucrats are currently registering. That would explain the tax receipts.
Economists at Goldman Sachs JB Were pre-empted the new governor’s thoughts when they analysed Australia’s June quarter economic data. They, too, were perplexed by the paradoxes:
“Employment growth is booming, retail sales growth has recovered impressively, credit growth at the business and consumer level has accelerated alarmingly, household income growth is nudging towards the pace last seen in the consumption boom of 2004, the profit share of GDP is at historical highs, business investment has soared to its highest share of GDP since the December quarter of 1989 and the federal government is embarrassed by fiscal riches.
“At the same time, consumer confidence has plummeted, far too few homes are being built for the underlying demographic demand, profit margins outside of the mining and financial sectors are in decline, investment intentions are being wound back, the painfully long awaited export recovery has failed to materialise and economic growth has plummeted to just 1.9%yoy – the slowest pace of growth since the 1991-92 recession (excluding the GST introduction period).”
It all seems a bit strange.
The Australian government recently railroaded new industrial relations laws through its majority-held parliament that effectively signal the end of the minimum wage, and of other worker benefits which Australian unions had fought for these past centuries. By taking the handcuffs off employers, the government’s intention is that an efficient and strong economy will ultimately result in better wages for all. After all, Australian unemployment is at record lows. How could workers not be in a good bargaining position?
When planning his industrial reforms, Prime Minister Howard drew upon data suggesting the average real wage in Australia grew by 14% between 1998 and 2004. This figure was arrived at by the Australian Bureau of Statistics, which asked employers what their wage bill was, and then divided that figure by the number of workers.
The University of Sydney conducted a counter-study over the same period, using a different method. The researchers simply asked workers how much they were earning. What they found was that 14% was a bit of a pipe dream.
The top 10% of wage earners saw their wages rise by 13.8%. The “average wage” had in fact increased only 2.6%, and the bottom 20% of earners had received only a 1.2% increase. These figures showed that the ABS method allowed for the wage increase for highly-paid executives to distort the numbers, and top-level executive remuneration in this country has been growing like it never has before.
Thus real wage growth in Australia is relatively moderate today. This, too, has surprised economists, who have been waiting for record-low unemployment to have the sort of effect it traditionally has – pushing up wages. This has featured as part of the inflation scare, but while inflation has been driven by higher commodity prices, wages have not followed.
Both the Australian and US central banks are in a quandary over their monetary policy decisions. Both fear inflation as the beast that must be slain. Both have been staring at economic data that is positive one day and negative the next. Rarely have economists been so far off the mark with consensus predictions as one figure after another surprises. When it’s all said and done, economists collectively really have no idea whether the Fed will next hold rates unchanged, ease them, or even raise them, or whether in Australia another rate rise is possible or probable.
Why don’t things simply work the way they used to?
Australia is not alone in finding unemployment is falling while worker’s wages refuse to grow. It is a phenomenon being experienced by every first world economy.
Morgan Stanley economist and celebrated “perma-bear” Stephen Roach has recently been travelling the globe. What he found was a similar story being played out in the world’s three largest economies – the US, Japan and Germany. In the US, unemployment has fallen 27% since mid-2003; in Japan it has fallen 21% since early 2003; and in Germany it has fallen 15% since mid-2004.
Yet none of these economies is showing any meaningful increase in real wages over the period.
The US is 57 months through its current cyclical upturn, yet real wages are tracking US$400bn below projections based on the last four business cycles. Japanese real wages began to improve in 2005, but have stagnated once more. And German real wages have actually declined in the last four years.
Yet in each economy, productivity has increased dramatically. The last ten years has seen 2.8% productivity growth in the US, up from 1.4% for the prior twenty years. Japanese productivity growth has measured 2.1% since 2003, up from 1.2% prior, and Germany has managed 1.7% compared to 0.7% pre-2004.
Says Roach: “Economics teaches us that real wages ultimately track productivity growth – that workers are rewarded in accordance with their marginal product. Yet that has not been the case in the high-wage economies of the industrial world in recent years.”
By Morgan Stanley’s estimations, real compensation share of national income has fallen in the G7+ from 56% in 2001 to a record low of 53.7% in 2006.
It may just be, says Roach, that in Japan and Germany improvements in the labour market are so recent that wages just haven’t caught up yet (shades of Australia?). However, the US experience pours cold water on this theory. Over ten years of productivity growth, wages have remained stagnant and the labour share of national income has moved lower.
Of course, such figures only go to confirm what we all have anecdotally suspected anyway – the rich are getting richer and the poor are getting poorer. Where have these productivity gains come from? From cutting labour costs.
This month Australians were astounded when St George Bank not only announced the retrenchment of 60 IT staff from one of its suburban centres, it flew in the Indians hired to replace them so that they could be trained by the very people they were replacing. Mortified retrenchees refused to do so, declaring it would be tantamount to digging one’s own grave.
This extraordinarily moronic PR exercise just goes to show that in the cruel, hard world of capitalism, compassion has no place. To date we have been scorning the advancement of “globalisation” based largely on the sterile homogeneity offered by the dominance of the global franchise – that which sees the likes of Starbucks sell something it describes as “coffee” on every city corner in the world. But what we really weren’t prepared for is that globalisation provides not only a global market for goods, but a global market for labour.
Investments consultants GaveKal have expected this for some time. GaveKal decree that the world order established by the Industrial Revolution is over, and that the new world order is driven by technology and information. With the instantaneous international communication offered by the internet, a corporation can rapidly determine wherever in the world opportunities are available to reduce costs.
It seems a while ago now that the world was shocked by the Nike “sweat shops”. Nike had outsourced its production to third world countries for miniscule wages that seemed criminal when stacked up against the sort of prices Nike was charging for its footwear. But the Nike experience seems old hat now, and that is because third world workers are actually benefiting from having the opportunity to earn a wage that might seem a pittance in the first world, but is still an improvement for the subsistence peasant.
Thus began the great outsourcing rush. This has led to the emergence of a new first world business model, as explained by GaveKal – the platform company model.
The simplest example of a platform company is one which designs and sells widgets, but has those widgets manufactured in China. The company pays a slim margin to the manufacturer, who carries all the risks of plant and labour, while the extraordinary profits accrue at home. This reduces both risk and cost, and requires a much smaller workforce.
St George is establishing a platform company model by being one of many companies across the world outsourcing call centre requirements to India. India has over a billion people, a large number of whom speak English and are well-educated. China has over a billion people who are not well-educated, but they can work in factories.
A global sweat shop? No. Both the Chinese and the Indians are better off as a result. They are earning higher wages than their parents ever knew. The only losers are those first world workers who are suddenly without wages.
And this is the big point of contention. How can, for example, the Australian government sit back and allow Australian jobs to disappear overseas? Does it not represent the Australian people? If companies are reducing costs, and increasing value to shareholders, then the government must only be supporting the rich at the expense of the poor! (Which, when you consider Australia’s right-wing federal government, is not a leap of logic for workers to make).
That is not the theory, however. The theory goes that if costs can be reduced then companies will make more profits. If they make more profits they can expand their businesses which will then require more workers. The difference is that those workers will have higher-paid jobs, because the low-paid jobs will continue to be outsourced to where they are cheapest.
The Milken Institute conducted a study in 2004.
It found that for every US dollar of corporate spending, the receiving economy (ie India in this case) receives 33 cents in the form of wages, profits and taxes. The US company on the other hand, saves 58 cents. With this saving the company can invest in more product development, pay higher dividends to shareholders, or both. The US consumer also wins because lower costs mean lower prices.
The call centre in Bangalore will also need to be fitted out with computer hardware, software, phone systems and so forth. Hence companies like HP, Microsoft and Lucent will benefit, as will service providers such as PriceWaterhouse who will audit the books. At the same time, young Indian workers are receiving wages that allow them, for the first time, to buy mobile phones, computers, iPods, whatever, again providing a beneficial flow back to corporations.
Thus the US corporation experiences savings, increased exports and repatriated profits. All in all a benefit of 67 cents, calculated the Institute, which is twice that of India’s gain. Where will that money go? Apart from dividends it will be invested in new businesses which will boost productivity and, more importantly, create new jobs.
So a job lost is more than offset by a job gained. And Milken has not included the fact that workers’ superannuation is invested in those same companies that are increasing shareholder value. Everyone’s a winner.
Or so the theory goes.
Research conducted by GaveKal has found that US university graduates are earning more now in real terms than ever before, and yet the number of graduates has increased. High school graduates have found their wages stagnant, and high school “drop-outs” have seen their wages diminish. If we compare these numbers to those described earlier form the University of Sydney, the obvious conclusion is that the outsourcing of jobs from the first world will only ultimately benefit workers remaining provided they have the requisite skill set.
The higher the skill set, the more sought after the worker, the greater the reward. That is why wages have only increased proportionately at the higher end of the market. The reason why productivity has increased in first world economies is not because workers are generating more for their dollar, but because companies have simply reduced the costs of producing goods and services, and hence increase profits. If you do not have that skill set, you are in for a rough ride.
Harvard economist Richard Freeman estimates the ascendancy of China, India and the former Soviet Union has added 1.5 billion to the global workforce. This has created what Roach describes as a global “labour arbitrage”. Companies have the opportunity to keep shifting jobs offshore for lower costs while the arbitrage window is open. As any financial market trader knows, however, arbitrage windows do not usually stay open for long.
Hence it is not hard to foresee that in the great scramble to outsource, wages will fall in the first world only as far as wages rise in the emerging world to meet them. Eventually a point of equilibrium will be reached. A boilermaker in China will earn the same effective real wage as a boilermaker in the US.
Should we thus be happy this adjustment won’t last for long? No. Morgan Stanley estimates that after five years of double-digit growth in China, hourly compensation for Chinese manufacturing workers remains at only 3% of levels prevailing in the major industrial economies. This could be a generational transition at best.
While governments such as those in the US and Australia are happy to stand by and let the trend continue, for the supposed good of the country, others are not quite so quick to let global capitalism find its own level. Europe, for example, boasts a much more socialist attitude, such that workers jobs and welfare are protected to a greater extent. The UK government has recently tried desperately, and vainly, to save iconic English car manufacturers.
The European economy has been one of the most sluggish in recent times. The Japanese experience in the 1990s is one of a desperate government attempting to prop up a failing banking system, sentencing the country to a decade of economic stagnation. Experience suggests that the more a government tries to protect its industry, the worse off it will be all round. Thus attempts to protect workers jobs will only prove temporary. Workers will suffer more generally if an economy is not allowed to find its own level, and achieve ultimate efficiency. Economic theory is not about immediate welfare.
Growing income disparity between those who have something to offer the world, and those who have not, is a very real fallout of globalisation. The owners of capital are in the box seat, and they can only find their situation improving. As we move down the income tree workers will become increasingly left out of the party.
This does raise another interesting issue, however. If wealth continues to be concentrated at the top end of the market, then the market for any goods and services will also become concentrated. Notes Roach:
“Contrary, to orthodox “win-win” theory, globalization is a highly asymmetrical phenomenon. Initially, it creates far more producers than consumers. It also results in extraordinary imbalances between nations with current account deficits and surpluses. And it has led to a widening disparity of the returns between labor and capital.”
Roach does not yet suspect that globalisation is thus unsustainable. But globalisation is a “mega-trend” of the new millennium that may well be about to hit a destabilizing phase. Surging corporate profitability has meant that returns on capital have never been greater. In the meantime, shares of labour income have never been lower.
“As day follows night, the pendulum will swing the other way – and so will the balance between real wages and business profitability. It’s just a question of when – and under what circumstances”, says Roach.
Is the revolution coming?