Stalemate on stagnant wage growth
One big reason the wages of working Australians are stagnating is that the owners of capital in this country have grown lazy and greedy, short-sighted and risk averse.
Josh Frydenberg did not put it in such blunt terms this week when he addressed the heavyweights of the Business Council of Australia (BCA), but the implication was clear.
The treasurer’s message to the BCA, repeated in many media appearances, was that wages will not grow unless productivity does, and productivity won’t grow unless business starts reinvesting more in new ventures, new assets, new capital equipment, and research and development.
But business isn’t doing that – or at least not enough. Instead, they are giving far too much back to shareholders, said Frydenberg. And he had some startling figures to back his argument
“Over the last 12 months, approximately $29 billion has been returned to shareholders in the form of buybacks and special dividends, compared to an average of $12 billion over the previous four years – a 140 per cent increase,” he told his business audience.
“Now it’s becoming the default option for companies to buy back their shares,” he later told Kieran Gilbert on Sky News.
This truth was not welcomed by many business leaders, fund managers and shareholders, who have been vastly enriched by this corporate behaviour.
“I don’t wait to be told by politicians as to what we’re supposed to do,” Mike Kane, chief executive of giant building-product company Boral, told Nine newspapers.
Other corporate leaders made the same point, if somewhat less stridently. Mining companies, which have lately been particularly prominent among those handing back outsize largesse to shareholders, were wont to insist that did not stop them “investing significantly”.
Some simply tried to ignore the elephant in the room, as though Frydenberg hadn’t raised the concern. In a response to his speech, posted on the BCA website, chief executive Jennifer Westacott said Frydenberg was “spot on to highlight Australia’s productivity challenge”.
“This is more than just a speech, it is a crucial signal to companies that the government is backing the economy, backing business and backing investment,” she said.
She made no mention of dividends or buybacks.
Likewise, Wesfarmers managing director Rob Scott delivered what The Australian called a “ringing endorsement” of Frydenberg’s speech. In reality, his comments, lifted from an interview on ABC Radio, were very carefully phrased and rather anodyne.
“The treasurer makes a good comment that companies, and CEOs, should have the courage to invest in the future,” Scott said.
Various commentators in the business media offered excuses – some legitimate, such as the largely Trump-induced uncertainty in the global economy – for the reluctance on the part of business to engage in job-creating investment.
David Koch, on Sunrise, put it to Frydenberg that if only the government would reduce the corporate tax rate, “then we would invest”.
Maybe Koch was just playing devil’s advocate, for we have seen the world’s biggest experiment in trying to induce higher investment and wages through corporate tax cuts.
In December 2017, the United States congress passed the $US1.5 trillion so-called Trump cuts. Since then, there has been growth in investment in America. According to Goldman Sachs, it surged 13 per cent in 2018. But share buybacks surged even more – up 52 per cent to $US819 billion for blue chip companies on the Standard and Poor’s index. Goldman predicts the figure for this year will be $US940 billion.
It has provided a huge windfall for the wealthiest 10 per cent of Americans, who own 84 per cent of all stock. Very little, though, has flowed through to wages. Indeed, says Nicki Hutley, partner at Deloitte Access Economics, “recent study of the benefits of Trump’s tax cuts shows there had been no impact on wages. Any growth can be purely related to the Phillips-curve relationship with unemployment.”
Which is to say, what little wage growth there has been in America is due to the low unemployment rate – not the tax cuts. Unemployment was trending down long before Trump came to office and was already close to 4 per cent before the tax cuts came into effect. It bottomed out at 3.6 per cent and now is trending up slightly again. The Trump tax cuts look increasingly likely to prove to be history’s biggest repudiation of the theory of trickle-down economics.
In truth, the Trump cuts only added momentum to a corporate trend of giving away profits rather than reinvesting, a trend that has been exacerbating inequality in America for a long time. Over the past decade or so, share buybacks have overtaken dividends as a way for companies to return cash to shareholders.
From 2008 to 2017, according to one analysis published last year in The New York Times, 466 S&P 500 companies distributed $US4 trillion to shareholders as buybacks, which equated to 53 per cent of profits, along with dividends of $US3.1 trillion. The story was headlined “End Stock Buybacks, Save the Economy”.
As Democrat senators Chuck Schumer and Bernie Sanders warned in a subsequent comment piece in the Times: “When more than 90 per cent of corporate profits go to buybacks and dividends, there is reason to be concerned.”
Clearly, companies that give away most or all of their profits to shareholders have little left over to grow and innovate. Underlining the point is the fact that America’s most innovative companies – the tech disrupters of Silicon Valley – do not hand back large dividends. Amazon has famously never paid a dividend but continues to grow on the strength of its share price gains.
So, how much kudos should Frydenberg be given for voicing concern about the rising tide of buybacks and special dividends in this country?
Not much, in Hutley’s opinion, for a couple of reasons. First, because the treasurer is not proposing to do anything about it.
“To think that companies will turn around now and say, ‘Oh, the treasurer says we should do something, so we’d better do it’, is, quite frankly, naive at best,” she says.
The second reason is that she sees the government being very late in recognising there is a problem.
“If you look at some of the speeches from the Reserve Bank … for the past five or so years, they’ve been asking why businesses haven’t invested more in this country. Why has the number of new businesses, start-ups, fallen significantly? For this is where you get growth and productivity and higher wages.”
The dramatic increase in buybacks Frydenberg spoke of is a recent development, but companies in Australia have long been exceptionally generous, compared with other nations, in their allocations to shareholders.
“If you look at the MSCI [Morgan Stanley Capital International, which tracks various aspects of stock performance] indices, dividends are around 4.5 per cent in Australia, versus just under 2.5 globally,” says Hutley.
As to why this is the case, Australia’s unique dividend imputation system has a lot to do with it, she suggests, as does our large superannuation pool. Both encourage investment in shares with high and reliable yields – that is, conservative, established companies – rather than in those with greater prospects of capital growth, which tend to be riskier.
Whatever the reason, though, she says: “Companies here would rather return money to shareholders than invest it in new forms of growth and risk.”
The pursuit of dividends has reached the absurd, as The Australian’s James Kirby showed this week, referring to Commonwealth Securities data on the most recent corporate reporting season. It showed Australia’s leading companies had managed to lift revenues by 4.7 per cent, and profits by the same amount.
But, he wrote, “when it comes to dividends, they are up by 6.1 per cent – mathematically this cannot go on forever”.
Kirby also noted the inherent contradiction between what Frydenberg is saying now and the fact that during the election “the Coalition campaigned hard on leaving the franked dividend regime unchanged. That policy was a vote winner and a logical outcome is that the dividend bias of our local market has been extended.”
Hutley says Frydenberg is engaging in “a bit of sleight of hand, a bit of distraction, a bit of ‘look over there, it’s not us, it’s them’ ”. Pointing at what the corporate sector is not doing, to divert attention from what the government is not doing.
“The timing is interesting,” she says. “There is quite a lot of pressure on the federal government at the moment in terms of fiscal policy.”
Hutley notes, in particular, how the world’s central bankers and economists, including Australia’s Philip Lowe, last weekend came to the consensus at a meeting in Jackson Hole, Wyoming, that the global picture was increasingly grim, and that governments had to start spending big to stimulate their economies.
“What we heard from Jackson Hole, not just from our own Reserve Bank governor, but from the IMF [International Monetary Fund] and others, was that monetary policy [i.e. the manipulation of interest rates] now has very limited impact, that there’s a lot of global risk, and that governments therefore need to be doing more on the fiscal front.
“But our federal government is looking for other means by which the economy can be stimulated other than fiscal policy, [because] that might impact the promised surplus.
“That is an ideological issue for them, very firmly entrenched and hard to move from.”
Having sold the electorate on the importance of a surplus and the gradual retirement of debt, the government now finds itself tied to exactly the wrong prescription for an economic environment where stimulus is required and money can be borrowed at negligible cost.
“I’m in that school of economists that think it’s more important to invest in counter-cyclical stimulatory measures than to sit on a surplus for the sake of it,” Hutley says. “We do need to balance the budget over the cycle, but we need to keep in mind where the cycle is. And we heard from Jackson Hole that risks are rising by the day.”
Professor Jeff Borland, a specialist in labour market economics at the University of Melbourne, says the problem with flat wages and the need for stimulus has become much more acute in about the past year.
“The simple way to think about wages growth over the long term is that it is explained by growth in the CPI [i.e. inflation] plus growth in labour productivity.
“The reason we’ve had subdued wage growth in the last six or seven years is that those things have both been low,” he says.
“A year ago, I was saying we might expect some slow recovery in those – not a wages breakout, but some faster rates of wage growth over the next two or three years. But I think given what’s happened in the last year we can expect a more prolonged period of slow growth.
“There’s no sign that price inflation is about to pick up,” he says. Indeed, the recent behaviour of bond markets suggests they expect none for decades.
“There are no signs of labour productivity picking up significantly as long as private investment remains subdued,” continues Borland. “The state of the world economy is a lot more uncertain.”
Borland notes that “a lot of public infrastructure projects are getting under way, mostly related to transport, which in the medium to long term may improve productivity, through things like reduced commuting times”.
But the potential benefits will take years to flow.
As the esteemed economist and New York Times commentator Paul Krugman said, productivity isn’t everything, but, in the long run, it is almost everything. And the picture there is bleak around the world, and particularly in this country.
There are two aspects to this. First, the benefits of productivity improvements have long been unequally shared. Andrew Leigh, the shadow assistant minister for Treasury and before that a professor of economics at the Australian National University, says the share of the economy accruing to the owners of capital and their workers has been shifting in favour of the former since the 1970s.
“The labour share is somewhere between 5 and 10 percentage points lower than it was in the 1970s, depending on how you measure it,” he says.
But worse than that is the fact that productivity growth has now almost stalled. In a recent piece for Inside Story, Leigh pointed to the June data from the Productivity Commission, showing that productivity growth in Australia, which has been declining since 2013, had “tumbled” to just 0.2 per cent.
He further noted fresh research from Treasury showing that even the most productive Australian firms – the top 5 per cent – had fallen off the pace compared with the top global firms.
“And then there’s the other 95 per cent. For these firms, productivity seems an alien concept,” he wrote. “In the past two decades, their output per hour worked has barely risen. In other words, 19 out of 20 Australian firms don’t produce much more per hour than they did when Sydney hosted the Olympics.”
They weren’t investing in productivity-enhancing new technologies, he wrote, “they’re not investing in anything at all”.
So dire is the situation that the Productivity Commission had to use a new term in its report. Instead of “capital deepening”, which refers to the measure of how much capital per worker has increased, the commission referred for the first time to “capital shallowing”.
So why is this happening? Leigh suggests the cloistered environment enjoyed by Australian businesses has much to do with it. Lack of competition obviates the need to innovate.
“One rule of thumb,” he wrote, “is that a market is excessively concentrated if the largest four firms control more than a third of it. Under this definition, ANU’s Adam Triggs and I found that over half of Australian industries are overly concentrated. In department stores, newspapers, banking, health insurance, supermarkets, domestic airlines, internet service providers, baby food and beer, the biggest four firms comprise more than 80 per cent of the market.
“The World Economic Forum’s ‘Global Competitiveness Report’ found that Australia does badly on ‘the extent of market dominance’, ranking us 53rd in the world.”
Complacent in their oligopolistic position, Australian firms compete by way of dividend size rather than by investing in better processes, attracting or training or paying better for workers.
And for all the current government’s boasting about its record of job creation, the unfortunate reality is that Australia is still a long way from the point where demand for labour will force pay rises.
Says Borland: “We have had, since the late ’70s, quite strong growth in the labour force, but supply has been increasing faster than demand.”
And that, he says, is manifested not just in unemployment, but also in underemployment. Forty-odd years ago, when part-time work and casualisation took off, the underemployment number was “virtually zero”, he says.
“That’s the big thing that has changed. Every time the share of part-time employment increases, underemployment goes up in lock step. Pretty consistently over 40 years. So, the rate of unemployment is no longer an accurate measure of spare capacity,” he says.
The current unemployment rate is 5.2 per cent. Once you also account for the number of people wanting more work, he says the real rate is equivalent to about 8 per cent.
So, what can be done? On Sunrise, Koch suggested the government should look to tax concessions for investment. Frydenberg said the government was looking at it. On ABC Radio’s RN Breakfast, Hamish Macdonald pointed out that the government had cut $4 billion from funding for research and development and might consider restoring that. Frydenberg said the government is consulting on it.
Leigh suggests more spending on education, and on infrastructure beyond new roads, as well as structural reforms to increase competition.
And there is much more government could do right now, says Hutley, were it not focused on the fool’s gold of budget surplus – increase welfare payments, bring forward low-income tax cuts, and accelerate infrastructure spending, particularly in the regions.
Borland, along with Lowe, points to perhaps the most practical solution of all. If the government truly wants to see wages increase, it could start by increasing the pay of public-sector employees.
By current indications, though, our treasurer would rather point at the other guilty parties in corporate Australia. “Look over there, it’s not us, it’s them.”
In fact, it’s both.
This article was first published in the print edition of The Saturday Paper on Aug 31, 2019 as "No pay, no gain". Subscribe here.