On Why Wages And Jobs Shouldn’t Be Inflation Cannon Fodder

Hearing Don Brash being wheeled out on RNZ as an expert on taming inflation must have caused whiplash among some listeners. Contrary to myth, Brash‘s track record is definitely not one to emulate. In reality, he took up the reins at the RBNZ in September 1988 long after the dreaded 1980s wage/price inflation spiral was over. (Inflation was running at only 6.3% in the calendar year 1988 and 5.7% a year later. Yesterday, inflation was way higher, at 7.2%.)

Brash’s signature style over the bulk of his term was his tendency to treat any signs of growth as an inflationary threat. So he would stamp on any green shoots of recovery with interest rate hikes until he was sure they were dead. His justification for this reign of terror was that he had to be ever vigilant about what might transpire 18 months down the track, should growth be allowed to ignite runaway inflation. No chance. The village was repeatedly levelled, in order to save it.

These days, RBNZ governor Adrian Orr doesn’t seem to have the future quite so much on his mind. He keeps clobbering the current inflationary spike with waves of interest rate increases before he’s had time to gauge what effect (if any) the last interest rate hike has had. Basically… The RBNZ is using a tool designed to stave off future inflationary risk, against the inflation that’s currently in the house. The tool is not fit for purpose. Ironically, Orr is doing so despite the fact that all the RBNZ predictions are that inflation will subside back to the target band quite naturally, come early 2024.

It should go without saying that this year much of the cost of living increases have been by-products of overseas factors – China’s Zero Covid policy, residual supply chain blockages, fuel and grain factors related to Ukraine etc. etc. All of those factors are now being filtered through the declining purchasing power of our sinking dollar. None of those external factors can be corrected by Adrian Orr hiking up the cost of borrowing for domestic firms and consumers. The current problem is that these overseas factors are now finally feeding into a widening range of local inflationary attitudes and expectations.

All of which means that the outlook for 2023 is pretty grim – and not only for the greedy people who took out huge mortgages when the storm clouds were already gathering. Workers are now directly in the firing line, because the main target of the interest rate hikes seems to be the wage inflation associated with the tight labour market. The mindset seems to be… Only by hiking up unemployment and making workers feel so insecure they will temper their wage demands can we stomp all over wage inflation, and thus bring down the cost of living. Dream on.

Unfortunately, even if and when the prices come down at the supermarket via this highly painful process, many of the people who made the ultimate sacrifice and joined the unemployment queue to bring this virtuous new inflation outlook about, will then be unable to pay the rent or the food bill.

The politics of quack inflationary medicine

National is already preparing the ground for this process. It wants to strip the RBNZ of the requirement to pursue policies of full employment and thereby retain only the pursuit of stable prices, by any means necessary. This will be only the start. In the process of demonising wage inflation, National will also be likely to freeze any further increases to the minimum wage, and roll back the collective bargaining rights that are currently helping workers to earn the wage increases helping them to keep up with the cost of living.

According to the current economic orthodoxy, “excessive” wages and “tight” labour markets are always seen to carry an inflationary risk. (Excessive profits are never seen in that same negative light.) At the moment, the RBNZ and National appear to be singing the same refrain: expand the precariat ! Yeah, right.

Footnote: For the record, the research on the impact of minimum wage increases on inflation (and the survival of firms) is mixed. The orthodoxy says that minimum wage increases create an artificial floor to wages that distorts the labour market, by preventing new workers from bidding for lower wages in order to get an initial foothold on the employment ladder. A race to the bottom in other words. What could possibly go wrong with those kinds of policy settings? No wonder National also promises to be tough on crime.

There is contrary evidence that minimum wage increases improve job satisfaction and productivity, reduce absenteeism, quitting and the related re-training costs, while reducing poverty and delivering only a tiny flow-on boost to the inflation rate.

In 2016, researchers from the W.E. Upjohn Institute for Employment Research examined the effect of prices on minimum wage increases in various states in the U.S. from 1978 through 2015. They found that "wage-price elasticities are notably lower than reported in previous work: we find prices grow by 0.36 percent for every 10 percent increase in the minimum wage."

In New Zealand, keep in mind that the “starting out” and “training” minimum wage is still only $16.70 an hour. (Hard to see how those pay rates can be a significant barrier to job market entry for young people.) The adult minimum wage has increased from $16.96 per hour as of April 1st 2018 to $21.20 as of 1 April this year, which means a 28% increase since Jacinda Ardern became Prime Minister. In line with the US research cited above, that would have caused less than a 1.06% increase in the inflation rate, phased in over four years. It seems worth the risk.

China changes

Although China is our biggest trading partner, there has been precious little local coverage of the 20th Communist Party Congress that will culminate early on Monday morning ( NZ time) with the unveiling of the new Politburo Standing Committee.

As expected, the Congress has already rubber-stamped Chairman Xi Jinping for a third five year term in office. If Xi declines to nominate a successor at this Congress, this will be taken to signal his intention to seek a fourth term. No surprise if that happens.

The Politburo Standing Committee is less predictable because the decision process is so opaque. As the South China Morning Post (SCMP) reported yesterday, four of the seven members of the Committee could stand down or be retired, and nearly half the Central Committee will be replaced. Those out the door will probably include China’s nominal No 2 political figure Premier Li Keqiang. This Congress will have to see a new premier appointed.

National People’s Congress chairman Li Zhanshu, 72, and Vice-Premier Han Zheng, 68, are being widely tipped to leave, having reached the unofficial retirement age of 68. Premier Li Keqiang, at 67, is still one year short of the customary retirement age but must step down as the premier, which is constitutionally limited to two terms.

Theoretically, Li, who is ranked second in the party hierarchy, could still stay on the Politburo Standing Committee and take up another position, such as NPC chairman. But sources now say the premier will most likely opt for full retirement.

And who else may be retired in line with Chairman Xi’s wishes?

Wang Yang, now the chairman of the Chinese People’s Political Consultative Conference, and Wang Huning, the ideology tsar, are the same age as Li Keqiang.

Right. And who are the likely rising stars, given that Xi has already over recent years, weeded out most of his potential rivals? The SCMP is picking these guys:

Ding Xuexiang, Xi’s trusted political aide, is a leading candidate to get a seat. Shanghai party secretary Li Qiang, despite an earlier debacle in handling a major coronavirus outbreak, is also in the race. Guangdong party secretary Li Xi is another strong contender to make it to the top, as well as Chongqing party secretary Chen Miner, another favourite of the president.

All will be revealed by Monday morning. If nothing else, this exercise will be a test of just how accurately external media like the SCMP can read the few signs available about China’s political pecking order. While the size of the Politburo Standing Committee turnover this year is unusual, the Congress has (so far) delivered few other signs of change. In Xi’s speech to the Congress he confirmed that the harsh and publicly unpopular Covid Zero policy will remain in place despite the hammering the Covid lockdowns have given this year to China’s domestic and export economies.

The Chinese economy is being beset by unexpected slowdowns in factory activity, by a shaky property market, by debt repayment headaches, and by Covid outbreaks that are causing fresh supply chain blockages, all of which is feeding into a slowing economy. None of these factors are being recognised – let alone addressed – by the party Congress:

GDP growth in the second quarter was the slowest since the initial Wuhan outbreak, and economists expect full-year expansion could reach just 4% or below this year. With the property market continuing to weigh on the growth outlook, economists say the need for more policy stimulus remains strong. The Communist Party’s top decision makers last week signaled a softening on the government’s growth target of around 5.5%, although they failed to announce any new stimulus policies to boost the recovery.

But there’s an upside to being a one party state. Since the expected gloomy third quarter economic figures would have put a dampener on Xi’s celebrations at the Congress, the figures are simply being kept in the bottom drawer until the party is over.

The take-away of all this for New Zealand? China’s expansionary spending saved us from feeling the worst effects of the Global Financial Crisis, but this time around will be different. Our biggest trading partner is in no shape to save us from the economic recession that’s currently knocking on our door.

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