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RODNEY’S RAVING
Labour's 4% unemployment rate target is political nonsense
OR
Desperate times call for misguided promises
This Raving shows why targeting 4% unemployment is misguided and would backfire. Recent New
Zealand experience tells us why targeting a 4% unemployment rate is misguided, which points to such a
target being motivated by "politics" rather than sound judgement. We only have to look at Governor
Bollard's misguided go-for-growth experiment in the 2000s to see why, as I do in this Raving.
When National leader Dr Don Brash was languishing in the opinion polls after taking over as leader in
October 2003 he delivered the infamous Orewa Rotary speech in January 2004 that focused on "the
dangerous drift towards racial separatism in New Zealand, and the development of the now entrenched
Treaty grievance industry". The speech achieved the desired result of boosting his and National's
standings in the polls, although he peaked too early for the September 2005 Election. I believe Labour
Leader David Cunnliffe's pledge to get the unemployment rate down to 4% should be viewed even more
cynically. If pursued it would ensure we either get hit with high interest rates and a recession or return to
the bad old days of the 1970s of double digit inflation that had lots of undesirable consequences.
Unfortunately, we seem to be drifting back to the bad old days of political parties promising things even they
should know aren't realistic in the hope of fooling some people come Election Day.
Introducing the Regional Barometer reports
If what happens to regional or city/district house prices, residential building or retailing are important to
you the new Regional Barometer reports should be a must have. Use the following link for info about
the regional reports - http://www.sra.co.nz/pdf/RegionalBarometers.pdf - and the following link to access
a subscription form that specifies the annual subscription prices, with discounts for existing clients and
multi-regions - http://www.sra.co.nz/pdf/SubscriptionRegionalBarometers.pdf. We will be marketing the
regional reports via seminars around the country starting in the upper North Island. If your firm would
like to be involved in these seminars as a sponsor or otherwise please get in touch.
Rodney Dickens
Managing Director and Chief Research Officer
Strategic Risk Analysis Limited
[email protected]
www.sra.co.nz
© 2014 Strategic Risk Analysis Limited. All rights reserved.
May 2014
While Strategic Risk Analysis Limited will use all reasonable endeavours in producing reports to ensure the
information is as accurate as practicable, Strategic Risk Analysis Limited, its employees and shareholders
shall not be liable (whether in contract, tort (including negligence), equity or any other basis) for any loss or
damage sustained by any person relying on such work whatever the cause of such loss or damage.
1
There is more than one route to a lower unemployment rate
The unemployment rate can be an emotive issue so let's look at it from an analytical perspective. There
are a range of factors that contribute to people being unemployed, including:
•
What economists call "frictional" unemployment; at least that was what is was called when I studied
economics. This relates to people who lose jobs or resign for a range of good or unavoidable
reasons and so find themselves temporarily unemployed while they look for a new job.
•
There are people who live in parts of the country where industries have declined and jobs have
been lost, but for various reasons, including the social welfare safety net, they remain where they
are rather than move to places where there are jobs.
•
There are people who for various reasons beyond their control struggle to get or retain jobs.
•
Some people work in seasonal jobs and so are unemployed for parts of the year.
•
There are people who declare they are looking for work when they aren't really because they have
access to other sources of income or support (i.e. this includes the infamous "dole bludgers").
•
There are periods when monetary policy is battling inflation or the government is battling to get
down a massive fiscal deficit and to achieve the goals there is a recession and a temporary or
cyclical period of above average unemployment.
If Labour' plan was to address some of the avoidable reasons for a higher unemployment rate all would be
great (e.g. encouraging a more mobile workforce; addressing reasons why people struggle to get or hold
jobs; weeding out genuine "dole bludgers"). But Labour's plan is largely just old-school-Keynesianism (i.e.
boost demand in the economy to boost employment), albeit dressed up with some interesting industry
initiatives that should stand or fall on their own merit rather than be linked to a dubious target for the
unemployment rate.
Based on the media coverage, Cunnliffe's plan is to:
"drive jobs growth through a combination of policies including more government buying of Kiwi-made
products, stimulating production of higher-value wood products to boost forestry jobs, and create jobs in the
construction sector via its 'KiwiBuild' plan to build 100,000 affordable homes over 10 years."
Source: http://www.sharechat.co.nz/article/1895d772/cunliffe-pledges-surpluses-and-to-get-unemploymentto-4-percent-by-end-of-first-term.html
What we should have learnt from Governor Bollard's go-for-growth experiment
The unemployment rate is inseparably linked to the inflation rate and while economists struggle to quantify
the rate there is a rate or range of rates that is consistent with the Reserve Bank's target of keeping inflation
low on average over the medium-term. I have estimated that the "equilibrium" or "inflationary-neutral"
unemployment rate in New Zealand is in the vicinity of 5.5-5.8%. This may seem high to some, but it is a
natural by-product of the reasons I have listed above for people being unemployed.
If Labour were to fix some of the solvable reasons for people being unemployed the equilibrium
unemployment rate would be lower. But getting unemployment down by boosting demand would result in a
self-defeating wage-price spiral (described below in the context of the role the unemployment rate plays in
the wage-salary bargaining process), much higher interest rates and eventually a recession that drives the
unemployment rate back up. Even if the unemployment rate is initially reduced by well-founded industry
initiatives the result will be a destructive wage-price spiral, which is why the industry initiatives should be
focused on as separate issues rather than being tainted by the link to a nonsense target.
We only have to look at what happened as a result of Governor Bollard's go-for-growth experiment in the
2000s to see that pushing the unemployment rate below the equilibrium rate using things that boost
demand rather than solving the solvable causes of unemployment is foolhardy and will end up in a
recession. This assumes the Reserve Bank is allowed to do its job, but if it becomes a casualty of the 4%
unemployment rate target the result will be a return to the destructive wage-price spiral of the 1970s and
first half of the 1980s that not so many people can remember but is not a desirable future.
A good starting point is to consider the unemployment rate as an indicator of bargaining power between
employees and employers. If low interest rates, as was the case in the 2000s, or initiatives to boost
spending in the economy, which is the Labour plan, drive stronger economic growth it will flow through to
While Strategic Risk Analysis Limited will use all reasonable endeavours in producing reports to ensure the
information is as accurate as practicable, Strategic Risk Analysis Limited, its employees and shareholders
shall not be liable (whether in contract, tort (including negligence), equity or any other basis) for any loss or
damage sustained by any person relying on such work whatever the cause of such loss or damage.
2
stronger employment growth and a fall in the unemployment rate. This is Economics 101 and it will work in
the real world, although it is only part one of the multi-part story that will be set in motion by the stimulus to
spending.
Stage one of the story is confirmed by the adjacent
chart. The blue line shows annual GDP growth, left
Correlation = -0.81
4
8
scale, while the thick black line shows the annual
* Advanced one quarter
percentage point change in the unemployment rate,
3
6
right scale. When economic growth accelerates the
2
4
unemployment rate almost always falls, while in the
odd occasion the relationship isn't maintained it
1
2
could as much as anything be because of the at
0
0
times large sampling errors in the unemployment
rate data the Reserve Bank commented on in a
-1
-2
Monetary Policy Statement last year. Equally,
-2
-4
Annual change in unemployment rate, lhs
when economic growth slows significantly the
GDP excl. Primary Production *, rhs
unemployment rate generally increases. For the
-3
-6
Mar-91 Mar-94 Mar-97 Mar-00 Mar-03 Mar-06 Mar-09 Mar-12 Mar-15
mathematically minded the chart includes a
correlation that at -0.81 is pretty high in the context
of the maximum possible negative correlation being -1.0 (i.e. it is a bit like getting an 81% mark in an
exam). The best fit is with GDP growth leading changes in the unemployment rate by one quarter.
So we can be pretty confident that Labour's plan to boost spending by a range of industry initiatives would
be successful in driving the unemployment rate down. So based on the first stage of the journey,
Cunnliffe's plan gets the thumbs-up.
The resulting fall in the unemployment rate would
Labour Cost Inflation & Unemployment Rate
give more bargaining power to employees vs.
Correlation = -0.86
employers and would result in larger pay increases
Unemployment Rate
4.5
Labour Costs * 12
(see the adjacent chart). The thick black line in the
Adv 3 qtrs
LCI Adjusted
4
11
right scale
left scale
chart shows a productivity-adjusted measure of
3.5
10
annual labour cost inflation calculated by Statistics
3
9
New Zealand, left scale. It measures labour cost
2.5
8
increases that can't be justified by productivity
2
7
growth and in that sense are purely inflationary, but
1.5
6
more on this later because it is too early to spoil
1
5
David's plan. The blue line is the unemployment
0.5
4
rate, right scale. The chart shows a strong inverse
0
3
* Annual average % change. Prior to 1992
-0.5
relationship between the two, as reflected in the
Prevailing Wage Index adjusted for productivity
-1
2
correlation of -0.86. The best fit is with the
Mar-90 Mar-93 Mar-96 Mar-99 Mar-02 Mar-05 Mar-08 Mar-11 Mar-14
unemployment rate advanced or shifted into the
future by three quarters.
The chart above shows that a natural consequence of getting the unemployment rate down would be higher
labour cost inflation approximately three quarters later. Employees would understandably take advantage
of the increased bargaining power. From the perspective of a Labour Government, stage two of the journey
most likely gets the thumbs-up (i.e. a shift in income from employers to employees). But the journey
doesn't end there because pay increases that aren't justified by productivity growth set in motion equally
understandable responses from employers that will end in a self-defeating wage-price spiral.
Annual GDP Growth & Change in Unemployment Rate
If labour cost increases aren't justified by productivity growth (i.e. by using smarter technology and/or
working smarter/more efficiently) it means the cost of production per unit produced increases. Faced with
rising unit production costs firms will understandably respond by putting up prices. Where this will lead
should be pretty obvious, especially to people who lived during the high inflation period of the 1970s, but I
will spell it out because for many the 1970s isn't in living memory.
The price increases will undermine the larger pay increases. But still armed with increased bargaining
power thanks to the unemployment rate being below the equilibrium level employees will go into bat for
even higher pay increases that will be achieved in part as employers scramble to fill job vacancies and in
doing so bid up wages and salaries. But this will result in larger increases in unit production costs so firms
will put up prices more. The end result will be self-defeating wage-price spiral that takes the focus of
While Strategic Risk Analysis Limited will use all reasonable endeavours in producing reports to ensure the
information is as accurate as practicable, Strategic Risk Analysis Limited, its employees and shareholders
shall not be liable (whether in contract, tort (including negligence), equity or any other basis) for any loss or
damage sustained by any person relying on such work whatever the cause of such loss or damage.
3
attention away from generating sustainable increase in real incomes via improving productivity growth (i.e.
by adopting smarter technology and doing things smarter and more efficiently).
This Raving overlaps with in an earlier Raving that investigated inflation causes, costs and cures. The key
point of the earlier Raving was that pursuing higher inflation for the sake of higher inflation is misguided
because it brings with it a range of undesirable costs and it is not a route to sustained increases in real or
inflation-adjusted incomes (see http://sra.co.nz/pdf/inflationcosts.pdf for the Raving in question).
But before an entrenched wage-price spiral became established Governor Wheeler would, as he is required
to do, hike the OCR to squash the wage-price spiral. The experience in the 2000s when Governor Bollard's
go-for-growth experiment drove the unemployment rate down below 4% and resulted in productivityadjusted labour cost inflation heading above 3% is instructive (see the bottom chart on page 3). As I have
covered in earlier Ravings, this was a misguided experiment that would inevitable end in tears. Reflecting
how misguided it was, after delivering the first OCR hike in January 2004 the Reserve Bank in March 2004
forecast that the unemployment rate would magically increase and that labour cost inflation would
subsequently fall (green and blue lines, respectively, in the left chart below). The Reserve Bank also
predicted sideways movement in the 90-day bank bill yield (green line, right chart), with these predictions
being proxies for OCR forecasts.
The first lesson from the monetary policy experiment in the 2000s is that the Reserve Bank's forecasts can
be motivated by wishful thinking more than sound analysis. But the lesson that is relevant to David
Cunliffe's plan is that the inevitable consequence of driving the unemployment rate down to 4% using
policies that stimulate demand in the economy will be higher labour cost inflation, high price inflation and
lots of OCR hikes that ultimately result in a recession and a rebound in the unemployment rate. In the case
of Governor Bollard's experiment in the 2000s the result was 13 0.25% OCR hikes over a three year period,
a recession that started before the financial crisis arrived and an unemployment rate back above 6%.
So if we set aside the politically-charged connotations associated with the unemployment rate and look at it
as a by-product of a range of factors that mean a sensible or sustainable rate is well above 4%, we should
conclude that the Labour Leader's plan is either foolhardy or purely politically motivated.
90-Day Bank Bill Yield & RBNZ Forecasts
Labour Cost Inflation & Unemployment Rate
4.5
4
3.5
Correlation = -0.86
Labour Costs *
Unemployment Rate
LCI Adjusted
Adv 3 qtrs
left scale
right scale
3
10
8
2
1
11
10.0
9
9.0
8
8.0
RBNZ
Forecasts
Mar-04
7.0
7
6.0
6
5
5.0
4
4.0
3
3.0
2
Mar-01 Mar-03 Mar-05 Mar-07 Mar-09 Mar-11 Mar-13 Mar-15
2.0
5
0
4
* Annual average % change. Prior to 1992
Prevailing Wage Index adjusted for productivity
7
6
0.5
-0.5
Quarterly average rates (%)
9
2.5
1.5
12
10
3
-1
2
Mar-90 Mar-93 Mar-96 Mar-99 Mar-02 Mar-05 Mar-08 Mar-11 Mar-14
While Strategic Risk Analysis Limited will use all reasonable endeavours in producing reports to ensure the
information is as accurate as practicable, Strategic Risk Analysis Limited, its employees and shareholders
shall not be liable (whether in contract, tort (including negligence), equity or any other basis) for any loss or
damage sustained by any person relying on such work whatever the cause of such loss or damage.
4