http://www.smh.com.au/articles/2004/05/28/1085641712893.html?from=storylhs
Unemployment limbo: how low should we go? By Ross Gittins
Sydney Morning Herald May 29, 2004
There was a time not so long ago when economists would laugh at people saying we should aim for an unemployment rate of 5 per cent. They're not laughing now.
The rate at present is 5.6 per cent. And, as Peter Costello delights in reminding us, this is as low as it's been in 23 years.
What that careful phrase means is that the unemployment rate has been below 6 per cent on two other occasions since the early 1980s: in 1989 to 1990 and in late 2000. On this occasion it's been below 6 per cent for the eight months since September last year.
The thing to note is that, on those two previous occasions, the rate didn't stay below 6 per cent for long.
In the first case, at the end of the '80s, unemployment didn't just edge back over 6 per cent. By 1992 it had bounced up to a new post-Depression high of almost 11 per cent.
In other words, unemployment fell below 6 per cent at the peak of the '80s boom, at a time when inflation was high and threatening to go higher, and the Reserve Bank had wound the interest-rate brakes up to 18 per cent. The recession of the early '90s soon followed. Advertisement Advertisement
In the other case, late 2000, the economy was falling into the post-GST pothole because of the collapse in home building. Unemployment jumped back above 7 per cent and it took until last September to get back below 6 per cent.
But here's the point: this time will be different. We're assured of this in Treasury's annual sermon, Budget Statement 4.
"The circumstances surrounding Australia's current economic performance are quite different to those earlier episodes and point to unemployment rates of 6 per cent or less now being much more sustainable," we're told.
The whole of BS4 is devoted to explaining how and why we've broken through to the sunlit uplands of lower unemployment - and, of course, to a commercial message about the further reform needed to ensure the rate goes even lower.
The one thing you won't find in BS4 is any reference to the "natural rate of unemployment", known in polite circles as the "non-accelerating-inflation rate of unemployment".
The NAIRU is the lowest rate to which unemployment can fall before shortages of labour lead to excessive pay rises and, hence, worsening inflation.
It's a great little concept, but no one can say with any confidence just where the NAIRU lies. Even so, it was the economists' belief that the NAIRU must be well above 5 per cent that caused them to laugh at punters who wanted to get unemployment down that low.
And the experience of the unemployment rate's brief period below 6 per cent in 1989-90 at the height of an unsustainable boom seemed to confirm economists in their pessimism about the NAIRU.
Are you getting the message? What BS4 is saying - without actually saying - is that the NAIRU has fallen, that it's now somewhere below 6 per cent and that it can fall further if we keep playing our cards right.
What is it that's lowered the NAIRU? Greatly improved macro-economic management and 20 years of micro-economic reform.
"Consistent macro policy settings, in a medium-term framework, since the mid-1990s are contributing to steadier economic and employment growth," we're told (my emphasis).
"Coupled with the increased flexibility of the economy flowing from the long-term program of micro-economic reform, this is making the economy less prone to the booms and busts of the past, which made it difficult to achieve a steady and sustainable approach to low unemployment levels.
"Flexible workplace relations and active labour market programs, along with increased participation in education and training, have contributed to a more flexible, adaptable and responsive labour market.
"Better incentives to participate in the labour force and for the unemployed to actively seek employment have come through reductions in income tax rates and reforms to income support arrangements."
Well, that's all fine and dandy. But how do we know the present unemployment rate of 5.6 per cent isn't below the NAIRU, thus making it inflation-inducing and sure to go back up like it did after 1989-90?
Because if you're in the danger zone you can see it in various other indicators of the tightness of the labour market. You could see it back then, but you can't see it now.
One obvious indicator to check is the growth in wages and other costs of labour to employers. Here the best measure is "nominal unit labour costs" (NULC), which compares the growth in labour costs with the growth in the productivity of labour to give the rise in labour costs per unit of output.
In 1989-90, NULC were growing at the rate of 7 or 8 per cent; today, they're growing at about 2 per cent, which is only a fraction higher than the 1.75 per cent they've averaged since 1991.
If labour costs are growing only 2 per cent faster than productivity, that's obviously consistent with keeping inflation within the Reserve Bank's 2 to 3 per cent target range.
Another indicator of emerging labour market tightness is rapid increases in the labour force participation rate. It was increasing rapidly in 1989-90, but it isn't at present.
A third indicator is the proportion of part-time workers who'd prefer to be working longer hours. Obviously, the existence of "under-employed" workers means we've got more labour supply in reserve than the official unemployment rate suggests.
We now have about 30 per cent of workers working part-time. It may surprise you that three-quarters of them are not actively seeking more hours.
But that means about a quarter of part-timers - and thus about 7 per cent of the labour force - would work more hours if the demand arose, thereby providing a further buffer against emerging wage and price pressures.
(Note that this measure of underemployment has been rising reasonably steadily over the years, starting at 2 per cent of the labour force in the late '70s.)
Treasury's conclusion is that the present below 6 per cent episode is "characterised by a structurally more sound economy, with steadier employment growth and low inflationary pressure".
"This suggests that low unemployment is now more sustainable and raises the prospect that unemployment can fall further."
I just hope Treasury's unbounded optimism on this isn't tempting fate. So let me add two words - touch wood.
Ross Gittins is the Herald's Economics Editor.