Labour market trends the clue to future rate cuts: Gareth Aird
GUEST OBSERVER
Labour market statistics are among the most valuable pieces of data we analyse to gauge the health and strength of an economy.
Trends in the labour market influence virtually every part of an economy. And they have a major impact on monetary and fiscal policy decisions as well as the functioning of society more generally.
The latest ABS employment report allows us to draw a line under the sand on how the Australian labour market performed over 2016. It also provides a good stepping off point for thinking about how conditions in the labour market will evolve over 2017.
In this note we take a frank look at how the Australia labour market performed over the past twelve months. We analyse key metrics like employment, unemployment, participation and hours worked. And we take a brief look at outcomes by state. We conclude by presenting our views on what we think is in store for the labour market over 2017 and what it means for policy.
1. Employment
We kick off with employment growth because job creation goes hand in hand with output growth (chart 1). Throughout 2016 average monthly employment growth was significantly lower than in was in 2015. The average monthly gain was 7.1k which is a third less than it was in 2015 (chart 2). As a result, annual employment growth in the year to December 2016 slowed to 0.9 percent compared with 2.5percent the previous year. And unsurprisingly, output growth eased over 2016. The latest national accounts put annual GDP growth at a below trend 1.8 percent in QIII 2016.
In addition to soft employment growth, the composition of jobs growth has been suboptimal. Part-time employment was the sole driver of jobs growth over 2016 (chart 3). The ABS estimates that part-time employment lifted by 126k over 2016 while full-time jobs fell by 34k. To be fair, there was a pickup in full-time jobs over the December quarter which provides a glimmer of hope that things may be improving. But over the calendar year as a whole, the news was ordinary for those seeking full-time work.
To recap, a worker is deemed to be employed full-time if they are working more than 35 hours a week. Working between 1 and 35 hours a week means a worker is considered part-time. So a part-time worker could be working a significant number of hours or hardly working at all.
The latest figures show that a part-time employee works on average 17.0 hours a week. A full-time worker on average clocks up 39.2 hours. Having this data enables us to calculate full-time equivalent (FTE) employment growth and the news here is particularly sobering (chart 4). On our calculations, FTE employment growth was flat in the year to December 2016. In other words, the Australian economy created no FTE jobs over 2016. This should concern policymakers because growth in FTE jobs should be a lot higher (1 percent or above) to take into account new entrants into the labour market. It’s therefore no surprise that Australia has near record higher underemployment (see section 3).
2. Unemployment
It’s fair to say that from where we were 18 months ago, the decline in the unemployment rate has bettered RBA and market consensus forecasts which previously had it stuck above 6 percent over 2016 and 2017. But before we get carried away, the unemployment rate moved a little lower over the year purely because of a fall in participation (see section 4).
Australia has a strong population growth rate and generally needs to generate at least 15k a jobs a month to stop the unemployment rate rising. But over 2016 the economy was generating half as many jobs a month and yet the unemployment rate moved marginally lower. This is reconciled by a fall in participation. On our calculations, the unemployment rate would have risen to around 6.2 percent if the participation rate has remained constant.
The slight downward trend in the unemployment rate has had a positive impact on job security concerns (chart 6). The WBC MI monthly gauge on unemployment rate expectations moved down a little over 2016 (a decrease indicates that respondents are less pessimistic about the labour market). This helps to loosen the consumer purse strings and since the spending of one person is the income of another, we also welcome the fall in job security fears.
There is more work to be done, however, because the unemployment rate is still above the level we associate with full employment (around 5 percent) and job security fears are still quite elevated even though they have been receding. Further, the unemployment rate in Australia is higher than the equivalent rate in the US, Japan and the UK – three economies that Australia is generally assumed to be doing better against (chart 7).
3. Underemployment and underutilisation
In the past the unemployment rate was deemed sufficient to measure labour market slack and therefore very little air time was given to the underemployment rate. But over the past two years it’s become increasingly fashionable to talk about the underemployment rate because it’s been rising while the unemployment rate has been falling. Underemployment provides a gauge of the proportion of people who are employed but whose labour is not fully utilised. That is, they have a job but want to work more and can’t find the work.
The underemployment rate largely tracked sideways at around 8.4% over 2016 which is near its record high. This is undesirable and means spare capacity in the labour market is a lot higher than the unemployment rate implies.
The sum of the unemployment rate and the underemployment rate produces the underutilisation rate which is the broadest measure of spare capacity in the labour market – it has been stuck above 14 percent for the past 18 months (chart 8).
The number of additional hours of work wanted by underemployed workers has been stable at around two days (or a little under 15hrs) per week since the mid- 2000s. This compares with unemployed people who are on average looking for an additional 33 hours per week1. To put it in layman’s terms, at the end of 2016,
8 1⁄2 percent of the Australian workforce wanted to work two more days per week than hey are currently working and 5 3⁄4 percent of the workforce were out of a job and wanted one. These numbers are too high and should concern policymakers.
There is a large pool of the workforce who either need work or want more work.
Having the information on hours of additional work sought enables us to construct an adjusted underutilisation rate. To do this we weight the underemployment rate to take account of the average underemployed person seeking 15hrs a week work compared with 33hrs for an unemployed person. This measure provides the purist measure of spare capacity in the labour market. It moved a touch lower over 2016 from 9.7 percent to 9.5 percent but it is very high by our historic standards and presently sits above the level hit during the GFC. In fact, you have to go back to the late 1990s for the last time the adjusted underutilisation rate was so high.
The data shows that the economy is operating well below its capacity and there is an output gap. As we have covered previously, this has dragged down the pace of wages growth and inflation.
4. Employment to population and participation
The share of the Australian workforce in a job trended down over 2016. The employment to population ratio ended the year 0.4ppts lower at 60.9 percent (chart 9). This shift downwards basically reflects employment growth running below population growth. Normally that would be associated with the unemployment rate drifting higher, but a decline in the participation rate has allowed the unemployment rate to grind lower. A declining participation rate and flat employment to population ratio means that the downward trend in the unemployment rate is overstating the relative strength of labour demand.
The participation rate fell over 2016 for cyclical and structural reasons .
The cyclical force dragging the participation rate lower over the year largely reflects the discouraged job seeker syndrome. The participation rate fell sharply over 2016 in the mining states of WA and QLD (chart 10). And more so for men than women. The big downturn in mining-related investment has greatly reduced job prospects for workers in these states. Some workers appear to have given up looking for employment and have left the workforce. As a result, the participation rate has fallen.
Structurally, the ‘grey army’ – those aged 65 and over – have continued to grow as a share of Australia’s population. This story will continue to play out over a long period of time and it will drag the participation rate down. Basically, the ageing of the population has increased the dependency ratio (the age-to-population ratio of those typically not in the labour force). This underpins the need for fiscal reform.
There is a misconception that Australia’s immigration policy will help to offset the impacts of the growth in the dependency ratio. It works in the short term, but it’s not a long term solution. As the Productivity Commission argued in April 2016, “the continuation of an immigration system oriented towards younger working- age people can boost the proportion of the population in the workforce and, thereby, provide a ‘demographic dividend’ to the Australian economy. However, this demographic dividend comes with a larger population and over time permanent immigrants will themselves age and add to the proportion of the population aged over 65 years.” In other words, it’s a policy more akin to kicking the can down the road.
5. Hours worked
Hours worked, as you would expect, is strongly correlated with output, consumption and employment growth. It is also a key input into examining productivity growth because we can measure output per hour (or unit of labour).
Monthly aggregate hours worked is quiet volatile so we look to the annual change in trend terms to best gauge what’s been happening in that space (chart 11). The
news is not good. But it’s not surprising given what the other indicators of the labour market aforementioned are suggesting.
The data indicates that total hours worked was just 0.4 percent higher in the year to December 2016. This is weak given population growth is running at 1.4%. As such, hours worked per capita fell over 2016 to a multi-decade low (chart 12). In fact, you have to go back as far as the recession of the early 1990s for when per capita hours worked was as low as it is now. This trend is concerning because it means that unless there is a big lift in productivity, output per worker will be weak along with per capita income. It’s no wonder that there has been no meaningful improvement in Australia’s fiscal position given per capita hours worked has been falling. As we covered back in October, the performance of the Australian economy looks far from spectacular on a per capita basis.
Labour market by state
Back in November we flagged that Australia has a new “two-speed” economy that comprises: (i) NSW and Victoria (driven largely by Sydney and Melbourne); and (ii) the rest of Australia (see here). The evidence is in, among other things, the labour market.
There has been little in the way of jobs growth outside of NSW and Victoria (charts 13 and 14). Employment growth in the Garden State has powered along, driven in part by particularly strong population growth. Jobs growth has slowed in NSW, but Australia’s Premier State put on a lot of jobs in late 2015/early 2016 and the unemployment rate is close to the level we would associate with full employment.
On the other hand, the impact of the downturn in mining investment is particularly evident in the labour markets of Australia’s two resource-rich states. Employment growth in QLD is down a sizeable 1.4% through the year to December 2016 while it’s down by a similar amount in WA. Things have picked up in SA and employment growth is running at a respectable pace. Jobs growth in Tasmanian remains soft but things improved a little in the second half of 2016.
The unemployment rates across the states vary just like the employment data (chart 15). The unemployment rate has trended lower in NSW and sits at a healthy 5.0%. In Victoria, despite solid jobs growth, the unemployment rate ended 2016 unchanged on a year earlier at 5.9% because of a rise in participation. For the rest of the country, the unemployment rate sits at or above 6.0%. The trend is WA is particularly concerning given the unemployment rate has been moving north. It ended the year 0.6ppts higher at 6.7%.
What can we expect in 2017?
Our frank assessment is that the labour market was soft over 2016. But there are tentative signs that things may be a little better in 2017, at least in the near term. More specifically, jobs vacancies and business surveys are pointing to a lift in employment growth.
The latest NAB Business Survey (January) showed a material jump in the employment conditions indicator (chart 16). This index has historically had a high correlation with the ABS labour force data. It currently sits at its highest level since 2011 which points to a near term lift in employment growth. The rise in the employment index is consistent with a lift in capacity utilisation which provides a source of optimism for business investment - an essential ingredient to long-run job creation. The ANZ jobs vacancies series also posted a solid rise in January (4.0%) and annual growth accelerated to its strongest pace since August 2016.
In addition to the business surveys, the lift in commodity prices over the latter part of 2016 is flowing through to export receipts which filters through to domestic income. Higher income growth supports consumption which ultimately underpins the demand for labour. So there are some causes for optimism.
But equally, there are plenty of risks. The rate cut chamber only has a few bullets left and even then, the ability of monetary policy to stimulate genuine economic activity from here is questionable. Consumer confidence is still fragile and the geopolitical backdrop suggests that the global economic outlook contains more uncertainties than usual. So while the business surveys suggest that near term employment growth should improve, that picture can change quite quickly, particularly given that the improvement in business confidence and increase in capacity utilisation has yet to translate into actual investment.
What does it mean for monetary policy
In our view, trends in the labour market are the one to watch in 2017 for clues on the next move in rates. Market participants became fixated on the inflation data throughout 2016 because the RBA eased twice, in May and August, when core CPI came in below target. But since Governor Lowe has been in the top job, inflation has continued to print below target and yet rates have remained unchanged. Concerns around the further build-up of household debt and strong dwelling price growth mean that it would take a slowdown in employment growth (or lift in the unemployment rate) for Lowe to entertain the idea of taking the policy rate lower.
We think that jobs growth will be sufficient to keep the unemployment rate crabbing sideways which should fend off calls for rate cuts. The risk, however, sits with easing over the next six months while ever inflation is below target. Labour market slack needs to be gobbled up before we start to see wages growth lift. And in our view, that’s some way off. As such, talk of rate rises is premature and we cannot see the case for the policy rate rising over the next year.
Gareth Aird is economist at Commonwealth Bank and can be contacted here.