A Macroeconomic Role for the IRC
By Tony Makin

Institutional Redesign as a Way to Reduce Unemployment

A fundamental tenet of economics is that low inflation and low unemployment are the main goals of macroeconomic policy. The desirability of these macroeconomic policy objectives is rarely questioned. However, some of the greatest debates in economics in the past, such as that between the Keynesians and Monetarists in the 1970s, have centred on the best policy
means of attaining them.

For instance, differences of view still persist amongst academic economists and policymakers as to whether fiscal policy, monetary policy, industrial relations policies, or some combination of these policy instruments is the best way to accomplish the two primary macroeconomic goals. Yet, there has been much less discussion of the appropriate assignment of economic institutions to the task of meeting these objectives. In what follows, this article in contrast proposes a new assignment of national economic institutions to achieve low inflation and low unemployment simultaneously.

In Australia’s case, the low inflation goal has been very successfully met since the early 1990s. Australia now has one of the lowest inflation rates in the world. Inflation fell from an annual average of 8 per cent in the 1980s to less than two per cent in the 1990s. In 1997-98, it was actually close to zero. On this front at least, the economy ranks at the high achievers’ end within the OECD region.

Yet, as is well known, the opposite is true for unemployment. The recent Federal budget presented the disappointing prospect of unemployment remaining around an average 8 per cent in 1998-99. Here, Australia unfortunately ranks at the low achievers’ end within the OECD, not far from European economies with highly regulated and inflexible labour markets, such as France, Germany and Italy which have had unemployment ranging persistently between 10 and 12 per cent.

One crude barometer of overall macroeconomic performance is the so-called ‘misery index’ (see chart 1). This index, first used in the 1970s to compare the economic policy achievements of US Presidents, simply represents the percentage sum value of an economy’s combined unemployment and inflation rates over any particular year. The higher the index value, the sadder the state of the economy. By this measure, it is true that the macroeconomic mood of the Australian economy is actually now comparable to that of the early 1970s. Yet, there is considerable scope to lower the level of economic misery by further reducing the unemployment rate by, for instance, at least another five percentage points. Such an outcome would restore the economy to the relatively blissful levels it enjoyed in the late 1950s and 1960s.
   

Lessons from inflation control

Australia’s much improved inflation performance since the beginning of the decade coincided with major institutional changes to the way monetary policy was conducted. Heavily influenced by the internationally renowned New Zealand model of monetary policy, these institutional changes mainly involved refocusing the Reserve Bank’s macroeconomic role, by identifying inflation control as its core function.

In light of the success on the inflation front, it is pertinent to ask whether anything can be learned about the way inflation was actually contained from an institutional perspective. Applying such lessons might then help solve the seemingly intractable unemployment problem.

An obvious lesson is that the virtual eradication of inflation in the 1990s owed much to having an independent public authority, the Reserve Bank, mainly think about one thing. More particularly, the successful defeat of inflation stemmed from an improvement in the central bank’s credibility as an independent authority capable of establishing price stability. This has now anchored the community’s inflationary expectations, which in turn has helped preserve the low inflation regime.

On the contrary, during the high inflation era of the 1970s and 1980s, the Reserve Bank had multiple objectives whose relative importance was ever changing. The objectives of monetary policy were especially obscure during the so-called ‘check list’ era of the 1980s when the Reserve Bank simultaneously targeted a range of economy wide variables, including inflation, unemployment, the current account deficit and asset prices.

The Reserve Bank now explicitly undertakes to maintain inflation within the range of 2-3 per cent on average over the business cycle. This is arguably close to world’s best practice in the conduct of monetary policy. Other countries that have formally set inflation targets for their central banks to hit are Canada, Finland, Sweden, the United Kingdom and Spain, although the target ranges still vary somewhat from country to country.

A new role for the Industrial Relations Commission

If reorienting the Reserve Bank’s monetary policy objectives was central to solving the inflation problem, what other independent institution in Australia could similarly have its role redefined for the purpose of bringing unemployment down? The obvious candidate here is the Australian Industrial Relations Commission (AIRC). Its decisions on the terms and conditions of those employed under federal awards directly affect the employability of a large proportion of the workforce and often have wider labour market effects through flow on decisions made by the corresponding state based tribunals.

As the independent authority most directly responsible for setting economy-wide labour market conditions, the AIRC could lower unemployment by focusing solely on the employment consequences of all of its decisions. It could also be given a brief to systematically and comprehensively review the employment limiting effects of earlier decisions it has handed down since the rate of structural unemployment began to rise significantly from the mid-1970s.

In practice, this may require Federal government legislation to change the focus and role of the Australian Industrial Relations
Commission. The AIRC’s brief would therefore be altered from one that is primarily concerned with the conditions of those presently in employment, the insiders, to one that is essentially oriented to the needs of those out of work, the outsiders. In this way, the AIRC would be explicitly re-oriented toward solving the problem of persistent nationwide unemployment.

Revised deliberation processes may necessarily entail the AIRC commissioning economic experts to advise on and estimate the unemployment effects of possible decisions. For instance, this could include an assessment of possible job losses or job gains likely to result from changes to the terms and conditions specified under various employment awards. In short, all wage-setting decisions of the AIRC would be based on principles that lead to full employment, first and foremost.

This proposed institutions/goals schema below would be fully consistent with the so-called assignment rule of matching policy instruments to policy targets. This rule was first advanced in the early 1950s by Dutch Nobel Laureate in economics, Jan Tinbergen.

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Policy Instrument     Institution           Macroeconomic Goal 
Monetary Policy       Reserve Bank     Low Inflation
Wages Policy          AIRC                  Low Unemployment 

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Tinbergen used mathematics to argue that to achieve macroeconomic goals effectively, there must be at least as many macroeconomic policy instruments at the disposal of the authorities, as there are policy targets to be met. The further distinction proposed here is that to achieve the traditional macroeconomic goals, there should be a unique assignment of the arms of policy to separate economic institutions, with each operating independently of government.

Keynesian economists would of course argue that as a macroeconomic problem unemployment should be reduced through greater fiscal activism – that is, by assigning the Commonwealth Treasury the task of reducing unemployment through the federal budget. The standard Keynesian approach to unemployment is to take the wages and all of the terms and conditions of the labour force as given.

It then prescribes raising public spending as a way of increasing aggregate spending in the economy and hence total available employment opportunities in the economy. Alternatively, Keynesians argue that income taxes should be cut to boost spending power of households for a similar economy wide spending effect. Budget deficits that arise as a consequence of either spending rises or tax cuts are considered somewhat immaterial. Even though the efficacy of fiscal activism as a means of stabilising employment levels was never firmly established by Keynesian economists, for some reason it remains an article of faith amongst many academic economists and policymakers.

Such thinking however belongs to another era when international financial markets exercised less influence over the behaviour of key financial variables, especially domestic interest rates and exchange rates, and, through them, overall macroeconomic performance.

Nowadays, under conditions of high international trade and capital flows, simple fiscal options involving boosting public spending and higher budget deficits are judged harshly by international investors wherever they occur. One reason for this is that irresponsible fiscal activism raises the risk of higher inflation in the future through subsequent monetisation of higher public debt. As well, foreign investors recognise that increased public spending is also likely to lower the economy’s domestic saving and hence its long-term growth prospects.

Conclusion

The real solution to the unemployment problem lies in addressing conditions in the labour market. This means reviewing the terms and awards previously established by the AIRC, including the legal requirement that employers cannot pay less than prescribed minimum rates of pay under enterprise bargaining.

The AIRC could be obliged for instance to consider the impact of its minimum wage (‘safety net’) decisions not only on those in employment, but on those presently without work and hence outside the industrial and employment relations system.

It may be argued that a better way of reducing unemployment is via thoroughgoing labour market deregulation, including the abolition of the AIRC itself. However, this radical solution is far more likely to fail at the political level if the recent history of attempted labour market reform is any guide. On the other hand, the above proposal is more practically and politically feasible. Moreover, charging an independent national authority with responsibility for reducing an economy-wide problem should be seen as an appropriate and commendable public policy response, given the prevalence of the view that low unemployment is primarily a government responsibility.

With a revised brief for the AIRC, Australia would have two independent institutions to achieve the two major goals of macroeconomic policy, low inflation and low unemployment. In sum, under the arrangements proposed above, the Reserve Bank would maintain its watch on inflation, while the AIRC would pursue a new activist role as the body charged with the responsibility for reducing unemployment.

About the Author:
Tony Makin is Associate Professor of Economics at the University of Queensland and author of Open Economy Macroeconomics, Addison Wesley Longman.

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