Cutting wages in a deep recession is not a sensible policy

Victoria went the so-called ‘double doughnut’ again today with zero new infections and zero deaths – the fourth consecutive day. It now has the lowest number of people sick with the virus (known) since the start of the pandemic in Australia in February. Only 38 active cases remain in Victoria after its 12 week lockdown. There is no community transmission reported now in Victoria and the other day Australia recorded zero (community transmitted) cases overall. So things are less tense than they were. I still haven’t been able to travel to my office in Melbourne which I have been away from since the lockdowns started in June. But hope springs eternal that the NSW government will open the border and let us move freely between the States. At the same time, the NSW government is demonstrating its economic incompetence. The State Treasurer announced that in the midst of the worst crisis in 100 years, it is cutting the pay of its public servants when it brings down its fiscal statement. Clue: when in a deep recession with records levels of household debt dramatically constraining growth in household consumption expenditure, which in turn, is killing growth, then the sure fire way to make matters worse by cutting the very source of consumption expenditure – yes, you get it – workers’ wages.

This is on the back of a decision by the NSW Industrial Relations Commission – Application for Crown Employees (Public Sector – Salaries 2020) Award and Other Matters (No 2) [2020] NSWIRComm 1066 (October 1, 2020) – which made the:

Determination that salaries and salary-related allowances in the awards the subject of the applications should be increased by 0.3% with effect from the first full pay period on or after 1 July 2020.

The government’s wage norm is that all “public sector employees receive a 2.5% increase each year”, which means a very modest real wage increase per year.

Initially, the NSW Government tried to introduce a wage freeze in June but the legislation was blocked by the Opposition and cross-bench members, which meant that it went to the Industrial tribunal (the Commission) for adjudication.

The Commission claimed that if there was a wage freeze, workers would endure a 0.3 per cent real wage cut, which was rather contentious given that the inflation rate is much higher than 0.3 per cent.

But using that logic, they determined to maintain the real wage value by awarding the 0.3 per cent increase.

Looking ahead, the NSW government has now said that in its upcoming fiscal statement due out in a few weeks that they will reneg on the 2.5 per cent wage promise next year and cut it by 1 per cent.

They claim this will help to reduce unemployment.

Well, wages are an income. Income promotes spending. Spending drives employment.

History tells us that when nations are caught in deep recessions, and the authorities start cutting wages, that the recession gets even deeper.

We are once again walking the plank for a flawed ideology.

And the other relevant factor is that the 2.5 per cent wage norm that the state governments adopted as part of their obsession with recording fiscal surpluses and apparently appeasing the (irrelevant) ratings agencies, was already creating recessionary tendencies before the pandemic hit.

Even the central bank government acknowledged that.

Public sector wages growth has been very low for some years because state governments have invoked wage norms, allegedly to protect their credit ratings.

It is one of those nonsensical arguments that keep repeating.

It goes like this:

1. We have to run fiscal surpluses and cut our borrowing.

2. Why?

3. To avoid the credit rating agencies downgrading our debt rating.

4. Why would that matter?

5. Because then our borrowing costs will rise.

6. But if you are running surpluses and not borrowing then how does the rating matter?

7. Duh!

The point is that these wage norms have made it much harder for workers to gain real wage improvements and have contributed to the escalation in household debt as workers use credit instead of wages growth to maintain household consumption expenditure.

There is clearly a case to be made for wages growth in the Australian state public sectors to increase considerably.

That is, certainly the view of the governor of the Reserve Bank of Australia, who also considers the state has the fiscal capacity to allow for an acceleration in public sector wages.

On August 9, 2019, the Reserve Bank governor, Philip Lowe, in evidence before the – House of Representatives Economics Committee – made mention of the fact that he “would like to see stronger wage growth in the country” and drew attention to the way in which the public sector “wage caps are cementing low wage norms across the country”.

Dr Lowe told the Committee that:

… the wage caps in the public sector are cementing low wage norms across the country, because the norm is now two to 2½ per cent, and partly that’s coming from the decisions that are taken by the state governments.

He also told the Committee that:

In the medium term, I think wages in Australia should be increasing at three point something. The reason I say that is that we are trying to deliver an average rate of inflation of 2½ per cent. I’m hoping labour productivity growth is at least one per cent-and I’m hoping we can do better than that-but 2½ plus one equals 3½. I think that’s a reasonable medium-term aspiration; I think we can do better, but I think we should be able to do that. So I would like to see the system return to wage growth starting with three …

… what is really important is the wage norms in the country … And the public sector wage norm I think is to some degree influencing private sector outcomes as well-because, after all, a third of the workforce work directly or indirectly for the public sector … But I hope that, over time, that balance could shift in a way that would allow wage increases, right across the Australian community, of three point something.

In the evidence to the House Economics Committee, Dr Lowe (referred to above) said:

The public sector, directly and indirectly, employs roughly one-third of the labour force, and they’re saying wage increases across the public sector may be averaging two per cent. That has as indirect effect on the private sector, because there’s competition for workers and it reinforces the wage-norming economy at two-point something …

… if … wages in the public sector were rising at three per cent, then over time I think we’d see stronger aggregate demand growth in the economy. I don’t think it would have much of a negative effect on employment; in fact, arguably it could be positive.

He also said that:

Most people are accepting wage increases of two to 21⁄2 per cent. And the public sector wage norm I think is to some degree influencing private sector outcomes as well-because, after all, a third of the workforce work directly or indirectly for the public sector. So I think it is an issue but, on the other side of the ledger here, it is important that state governments manage their budgets prudently. I have spoken to a number of state treasurers. They say, ‘We’d like to do more here but we’ve got a tough budget situation.’ So there is a balancing act to be completed here. But I hope that, over time, that balance could shift in a way that would allow wage increases, right across the Australian community, of three point something.

When I have given evidence in recent wage cases as an expert witness, this last quotation is used against me, where the government’s counsel says that the RBA governor was making it clear that state governments may not have the fiscal capacity to deliver higher wages and the soundness of their fiscal position is paramount.

Well, the economics debate has progressed over the last 12 months in so many ways.

It is clear that the Governor now considers the states have much wider fiscal space than has been commonly considered the case.

On August 14, 2020, the RBA presented their – Annual Report for 2019 – to the House of Representatives Standing Committee on Economics.

The same venue, a year later.

During the Question Time from the Committee, the RBA Governor, Dr Lowe was asked a question that bears on his interpretation of the available fiscal space at the State and Territory level.

He was asked by the Chair of the Committee:

Do you think the states should be doing more? When you’ve got the Commonwealth currently spending about $314 billion and the states only contributing about $44.8 billion so far in spending to assist, would an increase or a shift in responsibility to the states help aid the economic recovery?

He replied:

I think we need both the federal government and the state governments carrying their fair share … The measures to date from the state governments add up to close to two per cent of GDP. So, in aggregate, those measures are smaller; they’ve largely focused on supporting businesses through this difficult period and extra spending on health, and in some states there’s been extra spending on infrastructure and on housing and skills development.
Going forward, the challenge we face is to create jobs, and the state governments do control many of the levers here. They control many of the infrastructure programs. They do much of the health and education spending. They’re responsible for much of the maintenance of much of Australia’s infrastructure. So I would hope, over time, we would see more efforts to increase public investment in Australia to create jobs, and the state governments have a really critical role to play there.

To date, I think many of the state governments have been concerned about having extra measures because they want to preserve the low levels of debt and their credit ratings. I understand why they do that, but I think preserving the credit ratings is not particularly important; what’s important is that we use the public balance sheet in a time of crisis to create jobs for people. From my perspective, creating jobs for people is much more important than preserving the credit ratings. I have no concerns at all about the state governments being able to borrow more money at low interest rates. The Reserve Bank is making sure that’s the case. The priority for us is to create jobs, and the state governments have an important role there, and I think, over time, they can do more. But the federal government may be able to do more as well. We may need all shoulders to the wheel.

In later questioning he provided further clarification:

I think that’s where the debate needs to be: how much government spending should there be? Resolve that answer, and I’m not worried at all about the financing. The Australian and state governments will be able to finance themselves at extraordinarily low interest rates for a long period of time. So the financing constraint is not the issue.

Further, the RBA has also changed tack by tweaking its ‘long-dated outright transactions’ program, which involved quarterly purchases of government debt (for open market operations).

Since March 2020, they are buying government debt in secondary markets “to achieve a target for the yield on 3-year Australian Government bonds of around 0.25 per cent, as well as to address market dislocations” (Source).

By the end of September, the RBA had purchased federal debt worth $52,250 billion, and state/territories debt worth $11,098 billion.

Despite RBA denials, it is now funding significant proportions of the government deficits – both federal and state.

Harking back to the last great crisis

This harks back to the 1930s, when the British – Treasury View – claimed that fiscal policy was ineffective in changing economic activity (employment, unemployment) because it crowded out private spending or investment.

In 1929, British unemployment stood at 1.5 million (around 7.3 per cent of the labour force). By 1932, it had risen to 3.4 million (15.6 per cent).

The definitive data source is Feinstein, C.H. (1972) National Income, Expenditure and Output of the United Kingdom, 1855-1965, Cambridge, Cambridge University Press.

Here is the UK unemployment rate trajectory for the period 1925 to 1945. It was really only the onset of the War and the military spending that went with the prosecution of that effort that ended the Depression and brought the unemployment rate down.

When Lloyd George went to the British people on March 1, 1929 as part of his pitch during the British election campaign, with his plan ‘We Can Conquer Unemployment’, which involved proposals for large-scale public works programs, he was rejected by the people.

The government then proceeded to introduce policies that guaranteed the impending downturn would become the Great Depression – and it was the Labour Party in case you have forgotten your history.

At the time they were barely distinguishable from the ruling Tories they defeated.

The document was prescient in that it laid out what would later become known as Keynesian economics, even before Keynes published his General Theory in 1936.

In fact, John Maynard Keynes helped write George’s manifesto.

But the proposal came up against the dominant British Treasury view of the day and they responded in May 1929 with a “Memoranda on Certain Proposals Relating to Unemployment”.

Winston Churchill was the Chancellor at the time.

It has all the main points that are continually (still) rehearsed today by conservatives (and even so-called progressives):

1. The state would become a “dictatorship”.

2. Workers would be coerced into wasteful endeavours.

3. The fiscal position had to be balanced.

4. There is only a finite supply of savings and government borrowing would crowd out private investment spending.

Even though unemployment was starting to sky-rocket and bankruptcies were rising sharply, they claimed the best strategy was to continue to run orthodox budgets (balanced) and let the markets sort the developing crisis out.

They concluded that the public works programs would not increase net employment because the increasing public employment would come at the expense of a decline in private employment as a result of the reduced private and foreign investment.

Churchill told the House of Commons in April 1929 that he supported:

… the orthodox Treasury doctrine which has steadfastly held that, whatever might be the political and social advantages, very little additional employment, and no permanent additional employment can, in fact, and as a general rule, be created by state borrowing and state expenditure …

I discuss all this in this blog post – We can conquer unemployment (September 24, 2010) – which was written more than 10 years ago! Shock!

The fact was that the Treasury view meant that the Chancellor would tighten discretionary spending during a recession to offset the automatic stabiliser components of the fiscal balance (loss of tax revenue etc) so as to maintain the balance target.

In other words, the conduct of fiscal policy in this period was strongly pro-cyclical and it is no wonder the recession became a Depression.

The – 1931 May Committee Report – advocated harsh, discretionary fiscal consolidation and the September 1931 fiscal statement delivered on that recommendation.

The Chair of that Committee was – George May – who was a London businessman and saw the government through that lens. The Committee as forced on the Labour party by cross-party political pressure.

The Committee was stacked – “four of the May Committee were leading capitalists, whereas only two represented the labour movement”. When the Report was finished, the two trade unionists refused to sign off on it, such was the recommendations.

The May Committee Report is very apposite today.

It recommended:

1. Wage cuts for public servants – teachers, police etc.

2. Cuts to unemployment benefits by 20 per cent, at a time that unemployment was rising sharply.

3. Massive cuts in overall public spending.

4. A general campaign to cut wages throughout the UK.

We learn that the May Report (commissioned by a Labour government no less) was a Trojan horse:

… to be used as a weapon to use against those Labour MPs calling for increased public expenditure. What it did in fact was to create abroad a belief in the insolvency of Britain and in the insecurity of the British currency …

Do I hear 1976 ringing in my ears. Dennis Healey. IMF bailout. Labour Party does it again …

The then chancellor – Philip Snowden – along with PM MacDonald were big supporters of the May Committee recommendations.

Clement Atlee – at that time, a Labour MP, said that Snowden had a “misplaced fidelity to laissez-faire economics.”

The internal rifts in the Labour government ultimately brough it down.

The point is that the wheel just keeps turning.

Conclusion

Cutting wages in a recession to ‘save’ money is one of the most misguided strategies a government can ever introduce.

The state governments have been given the imprimatur by the currency issuer (RBA) to spend heaps.

The RBA is buying up lots of state government debt.

There is no financial crisis – just a real one – unemployment and lost production.

That is enough for today!

(c) Copyright 2020 William Mitchell. All Rights Reserved.