Monday, August 26, 2013

Different Wage-Setting Methods and the Responsiveness of Wage Growth in Australia

In Australia, annual wage inflation, as measured by the Wage Price Index has tended to stay around 3-4 per cent over the past fifteen years (see graph below).  By the term ‘wage inflation’ I mean wage growth absent any changes in hours worked or changes in workforce composition, which is what the WPI is designed to measure. This might be considered a fairly narrow range for wage inflation; by contrast, while annual consumer price inflation has often been around 2-3 per cent over the same period, it has been somewhat more volatile, even without the period (2nd half of 2000) in which the Goods and Services Tax was introduced.
From this, it looks like wage growth in Australia is not all that responsive to changes in the economy, at least in the short-term. I’ll leave it up to the individual reader to decide whether that is a ‘good’ or a ‘bad’ thing. The main theme of this post is not to evaluate how ‘responsive’ wages should be, but try to give a sense of the contribution that each wage-setting method makes to the overall variability of wage growth.
In line with the Australian Bureau of Statistics’ Employee Earnings and Hours survey, employees in Australia can be roughly divided up into three types of wage-setting method: awards, collective agreements, and individual arrangements. There are also working proprietors of incorporated businesses, but they make up only a small percentage of employees.
According to the Employee Earnings and Hours survey, over the past fifteen tears, around 15-20 per cent of employees in Australia at any one time have been paid at the award rate. Award rates include the ‘minimum wage’, but also minimum rates of pay for employees across a range of job classifications. Wages for these awards are (typically) set ‘centrally’ once per year through an annual wage review, which is currently undertaken by the Fair Work Commission. With some exceptions, over the past fifteen years, the increases to the national minimum wage have tended to be between 2.5 and 4 per cent each year (see graph below).  However, the relevant commissions have up until the past few years awarded ‘flat dollar’ increases, which provide for lower percentage increases for employees on higher award rates of pay. Given this, award-reliant employees have probably, on average, tended to receive increases of between 2 and 3 per cent each year, assuming that award reliant employees are bunched towards the lower award rates of pay.
Over the past fifteen years, around 40 per cent of employees have at any one time had their wages set by collective agreements. Enterprise bargaining agreements were introduced in the early-1990s, allowing for agreements on the wages and conditions of employment to be struck between an individual employer and a group of employees. On average though, the average annualised wage increases for these agreements – at least for registered federal collective agreements – have tended to be almost always between 3.5 and 4.5 per cent in aggregate (see graph above).   Hence, wage increases for collective agreements appear to be the least ‘responsive’, or possibly more correctly the least volatile, of the three wage-setting methods.
One might argue that if you strip out from the WPI wage increases for collective agreements and awards, then what is left - essentially wage increases for individual arrangements - is the part that ‘best’ reflects labour market changes. To illustrate this, I have calculated year-ended increases for an ‘adjusted WPI’, which has been calculated as follows:
Adjusted WPI/year-ended increase for individual arrangements =
(Year-ended increase for WPI –
(proportion of employees on awards)*(year-ended increase for awards) –
(proportion of employees on collective agreements) * (year-ended increase for collective agreements))
/(1 -  proportion of employees on awards - proportion of employees on collective agreements)
Note the calculations are a little rough, but I don’t think it detracts from the main points.
·         The proportions of employees on awards and collective agreements are taken from the biannual Employees Earnings and Hours survey (i.e. they change only every two years, although one could interpolate the changes between surveys).
·         The year-ended increases for awards are the most recent percentage increase awarded for the minimum wage by the relevant federal commission, adjusted downwards by a quarter in the years when there were ‘flat dollar’ increases for awards.
·         The year-ended increase for collective agreements is the average annualised wage increase for current registered federal collective (enterprise) agreements.  This series does exclude state collective agreements, and it does not exactly show what wage increases for these agreements were over the past year, given that agreements can run multiple years. If I’m ever in a situation where I need to refine this methodology a bit further I’ll tinker with this series, but for now I think it will do.

As you can see from the graph above, the ‘adjusted WPI’ was around 2 per cent in year-ended terms at the start of the millennium, then moved up to around 5 per cent when the labour market was tight in 2005-2006, and has moved back down to the 2-3 per cent range following the global financial crisis. This series seems to me to be more reflective than the ‘ordinary’ WPI of the relative strength or weakness in the labour market over this period. Given this, it could be an easier series to forecast, although obviously to get an aggregate wage growth forecast you would have to add the effects of awards and collective agreements back in. The adjusted WPI’s correlation with employment growth (lagged four quarters) is a touch stronger than the ordinary WPI. Where both fall down is when employment growth plummeted following the height of the GFC, which might well reflect downward ‘stickiness’ of wages.
While I said that I’m not interested here in evaluating whether a particular level of ‘responsiveness’ in wages is ‘good’ or ‘bad’, it would be interesting to see how employers with collective agreements respond to economic shocks compared to employers paying award rates or with individual arrangements with their employees. I am sure there is probably a lot of evidence in terms of the effects of various pay-setting methods on activity or productivity or prices, but I wonder if anyone has specifically looked at the short-term responses of employers to economic shocks based on their pay-setting methods. If your pay-setting method means that wages do not move around much, are you more likely to change employment instead, or does it make little difference? Are relatively stable wage increases harmful or helpful? I’ll leave those questions for someone else to consider.    

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