We’re about to pay the price for lazy policy with inflation

The Fair Work Commission (FWC) wage decision — and the government’s response to it — clearly demonstrate that senior policy makers do not yet appreciate the potential dangers of Australia’s recent inflation spike.

The FWC increased the minimum wage by $40 a week, or 5.2%; above the most recently reported inflation figure of 5.1%. Award wages linked to the minimum wage will either increase by $40 a week or 4.6% if they are currently set at $870 per week or above.

The FWC claimed that, while its increase of 5.2% would not threaten the performance of the economy, an increase of 5.5% would pose a real risk of a significant adverse effect. This statement strains credibility.

But it is important to understand exactly what risks are being amplified (or ignored) by this decision.

Some may argue that because ‘business as a whole is very profitable’, it can afford to pay workers more by just reducing profits and this won’t have a negative effect at all. This argument fundamentally misunderstands both the nature of business and how profit is generated.

Unlike the FWC and its aged awards process that applies across sectors and industries, there is no collective ‘business’ that can make decisions on the same scale. Each individual business makes its own decisions, based on its circumstances, and sets its prices relative to its costs and its market.

Most businesses, by number if not turnover, are small businesses and almost all of them are run by individuals just trying to make the best decisions they can for their business and their families. The profit they make is what’s left over at the end, not a percentage they dial up from the start.

Not that we should give the typical complaints of business that wage increases will be unaffordable more credibility than they deserve.

To be fair, it is no doubt true that some businesses have been squeezed by the pandemic and supply chain disruptions. A significant increase in wage costs at this time will be unwelcome; though given the tight labour market, wage rises seem inevitable.

The FWC decision, and the principle it establishes that workers should be protected by the FWC against real wage falls from inflation, is likely to drive further increases in inflation. Especially if it is replicated across the broader economy — and it hard to see how it won’t be.

The unfortunate reality is that these wage rises are going to feed into an economy that is already running far too hot. It can no longer be credibly claimed that the inflation we are currently experiencing will resolve itself in the short term.

The sense that the real problem was supply chain disruptions from the pandemic and the effect of the Russian invasion of the Ukraine was not correct. Unemployment does not reach 3.9% because of supply chain disruptions.

It is now clear that fiscal and monetary policy delivered excessive stimulus in 2021, when the economy was already on the rebound from Covid. Australia was not alone in making this mistake: the United States is in a worse position now precisely because its stimulus was even more excessive. High inflation is again a global phenomenon.

Both the RBA and the US Federal Reserve are in an aggressive tightening cycle, but other branches of government do not yet see the scope of the problem. The economy, which for years has appeared weak when it was deceptively strong, now appears strong but is deceptively weak.

High inflation is a macro-level threat to the economy. Inflation is already predicted to rise to 7% or more, and absent serious intervention, it looks increasing likely to stay high for an extended period of time.

The big problem for those trying to protect workers against falls in real income is that such a fall is almost an inevitable consequence of combatting inflation.

One way to reduce inflation is by holding back growth in nominal wages, a strategy deployed by Hawke and Keating in the 80s Accords to address inflation at the levels we are seeing today. However, as shown by their submission to the FWC, the current government opposes this strategy.

Another is through fiscal consolidation — cutting spending or increasing taxation, or both. Unfortunately fiscal consolidation has proven to be impossible for the past decade or more. Both Labor under Wayne Swan, and the Coalition under Hockey, Morrison and Frydenberg, met incredible resistance to creating a sustainable surplus.

The government appears to be pushing most of the responsibility for dealing with inflation to the RBA through increasing interest rates. While this is correct in one sense — inflation is the RBA’s job, after all — the potential downsides are significant.

The market is pricing in increases in interest rates at a level and speed beyond anything the RBA has done since it gained independence. There is a significant prospect that the RBA will tank the economy to save it from inflation; by accident if not by design.

The real risk is recession, something Australia has not really experienced since the early 1990s. If this happens it will not be caused by the FWC decision on its own. Nor will it be solely the fault of the current, or previous, government.

The unfortunate fact is policymakers in Australia have not given economic and fiscal policy the level of care and attention it deserves. Both sides of politics have stopped caring about economic efficiency in favour of distributional politics.

We may be about to see if they have the ability to make tough, unpopular decisions in the country’s best interest. Early signs are not great.