ECONOMIC ISSUES

Measuring the Labour Market Downturn

Insights

What Has Happened?

The COVID-19 epidemic catalysed the downturn in Australia’s economy, with expected growth in 2020 estimated at –6%. In other words, Australia’s GDP – the value of all goods and services we produce as an economy – is expected to shrink by 6% in 2020. But there are some indicators that Australia’s economy was already struggling.

Even before the outbreak of COVID-19, Australia was faced with very soft economic growth (being a modest 1.9% in 2019, well below the long-term trend of 3.25%–4%). Unemployment had also levelled out at around 5%, before slightly increasing to 5.2% towards the second half of 2019, indicating spare capacity in the labour market. Australia recorded a per-capita recession – when the economy grows at a slower rate than population growth – in early 2019.

All these stark figures painted an already uncertain future for employment in Australia. After all, a slowing economy signifies poorer employment prospects, right? But perhaps what few people predicted was the impact of a global pandemic on Australian employment levels.

Employment Trends (ABS)
Figure 1: Changes in Unemployment, Underemployment and Underutilisation

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Definitions

Unemployment, underemployment, underutilisation, labour force participation. All these terms sound similar enough, but they measure very different things, and so their statistics will also be very different. So what do they actually mean?

The unemployment rate is simply the percentage of people who are actively looking for work, out of the total labour force (comprised of people working at least 1 hour per week and those who are actively looking for work).

The underemployment rate refers to the percentage of people who are working that wish to work more hours. For example, you could be a part-time worker working 15 hours a week, but you want to be a full-time worker.

The underutilisation rate is the unemployment rate plus the underemployment rate.

The labour force participation rate is the percentage of people between the ages of 15 and 65 (regarded as the working years of your life) who are either working or unemployed (actively looking for work).

With that in mind, we can take a look at the impacts of COVID-19 on the workforce, and truly understand what is happening.

The increase in unemployment from 5.2% to 6.2% across April may not sound profoundly terrible, but it masks something far worse. In April, the unemployed population only rose by 104,000, but almost 600,000 people lost their jobs. That means that almost 500,000 people who are no longer working are also not looking for a job. Indeed, this is reflected in the labour force participation rate, which fell significantly more, from 66.0% to 63.5% across April. Additionally, underemployment rose from 1.2 million to 1.8 million people. Therefore, around 600,000 additional Australians had their working hours cut in April, and would be willing to work more hours if it were offered to them.

So when we take a look at a (rather) small increase in unemployment, we need to remember that the definition of unemployment is actually quite narrow, and does not capture the entire status of the Australian workforce.

Indeed, we can see in Figure 1 above that unemployment did not change significantly, while underemployment and underutilisation rose by a much greater magnitude.

The Cycle of Money

In times of financial strife, peoples’ financial habits can in part work to prolong recession. When people are laid off from their jobs and placed on government benefits, they often receive lower incomes. Other workers may retain their jobs, but face pay cuts. Overall, in times of financial difficulties, people’s average incomes fall, so they have less money to spend on goods and services. Since labour is a derived demand, demand for labour will fall.

Consumers are also more careful with their money. In other words, they will be less willing to spend, so their average propensity to consume (APC) falls and their average propensity to save (APS) will rise. This will reduce the level of consumption in an economy, reducing demand for goods and services. If there is less demand for production, firms will simply reduce their workforce, leading to higher unemployment.

Constructive Criticism - The Jobkeeper and Jobseeker Payments

The $130 billion system of wage subsidies known as the Jobkeeper payments will subsidise employers $1500 per fortnight to pay eligible employees. Around 6 million employees, or around 50% of the workforce, are eligible. This will ensure that businesses can afford to retain staff in the short-term (who would have otherwise been laid off as businesses seek to cut costs), thus minimising increase in cyclical unemployment.

Despite the positives of the Jobkeeper payment in alleviating unemployment, let’s consider a few criticisms of the program, as outlined below.

  • Firstly, casual employees who have not worked for the same employer since March 2019 are not eligible. Therefore, employers may be more inclined to retrench casual employees. Because around 50% of 15-24 year olds work as casual employees, compared to around 21% of the total workforce, they are much more likely to be retrenched. This will worsen levels of youth unemployment, indicated by a 2.2% increase to 13.8% in April, compared to a 1.0% increase for the economy overall. Casual workers are more likely to be low-income workers, so higher levels of retrenchment can worsen inequality.
  • Around 750,000 workers are still classified as employed but are not working at all. But they are still counted in the labour force, right? Yes. This can skew the labour force participation rate significantly. In fact, if we were to consider only those employees who were actively working, labour force participation would be closer to 57%.
  • The Jobkeeper payment is a flat rate of $1500 per fortnight. While some employees could face a pay cut, others will receive higher incomes than they did previously. Thus, Jobkeeper may temporarily reduce inequality, because low-income, lower-skilled workers are able to retain their jobs and may also earn more than they would have before the subsidy. Future increases in structural unemployment are mitigated, because low-skilled workers will face difficulty competing for the few low-skilled jobs available if they are retrenched. By preventing their retrenchment, the possibility of future structural unemployment is reduced. However, the fact that some individuals are better off in the short-term during an economic crisis can be regarded as fiscally wasteful, and the government has proposed amendments to the Jobkeeper payment that could see subsidies indexed to the incomes of individual employees, up to a cap of $1500 per fortnight.
  • The subsidy is expected to end after 6 months. Some employers may not be able to pay staff salaries without a subsidy, potentially causing a spike in unemployment.

In a similar manner, the Jobseeker payment, which is paid to unemployed individuals, has been temporarily doubled to $1100 per fortnight. While this will temporarily boost the income of unemployed individuals and reduce relative poverty in the short-term, such payments will return to their former level of $550 per fortnight after a six-month period. This will increase relative poverty levels, especially because the unemployed earn significantly below the Australian average to begin with.

These two programmes, amongst other stimulatory measures, will contribute to a Budget deficit of between -7% and -12% of GDP. This represents a heavily expansionary stance compared to the estimated Budget surplus of $7.1 billion in 2019. We can represent this graphically using a Keynesian Aggregate Demand Cross.

Figure 2: Keynesian AD Cross


By including government expenditure (G) within aggregate demand, we see that the aggregate demand curve rises from AD1 to AD2, resulting in an increase in total expenditure from E1 to E2 . Income (and thus economic growth) will grow by a greater than proportional value, as per the multiplier effect.

Therefore, the Jobkeeper and Jobseeker payments will increase consumption levels, since businesses and consumers will use their additional income to purchase goods and services. Because labour demand is derived from the demand for goods and services, the additional consumption will limit increases in cyclical unemployment (which results from a fall in demand for production).

While a deficit (which occurs when the government spends more money than it receives in taxes) may sound daunting, let’s remind ourselves what would happen if the government continued to pursue its coveted budget surplus. Unemployment would be much higher, there would be higher levels of relative poverty, and the economic contraction would have been far worse. Therefore, a budget deficit, which allows for a highly expansionary fiscal stance, is critical in dampening the effect of a downturn.

How Effective Will it Be?

In response to the domestic downturn instigated by COVID-19, the Reserve Bank of Australia (RBA) cut the cash rate from 0.75% to a historic low of 0.25% in March this year. In theory, this would stimulate consumption through two main mechanisms:

  1. Savings and investment channel: Consumers have less incentive to save because they will receive less interest for their savings. They will also be more attracted to borrowing due to lower interest rates. Since Y=C+S, a fall in savings will correspond to an increase in consumption.
  2. Cash flow channel: Lower interest rates for households with variable-rate debts (such as some mortgages) will lead to lower interest repayments, thus increasing disposable income and consumption.

By boosting consumption, the demand for goods and services will increase, thus boosting demand for labour and helping to reduce unemployment.

But there are a few roadblocks to these theoretical outcomes. Firstly, consumers are much more careful with their money during times of financial difficulty, and may be more inclined to save rather than spend. Further, approximately 30% of Australian households are in mortgage stress, and may be more inclined to use any extra savings to pay off their mortgage rather than consume goods and services.

Australia also doesn’t have a lot of “wiggle room”, because lowering the cash rate further would lead to a zero cash rate, and even a negative cash rate. Negative cash rates are interesting, because they imply people are rewarded for borrowing money, and punished for saving money. The potential (although theoretical) benefit of this? People will take out more loans and purchase more goods and services. This will stimulate aggregate demand by boosting consumption (and possibly business investment as well):

AD=C+I+G+(X-M)

But remember, this is all theoretical, and negative interest rates are uncharted territory and unlikely to occur in Australia. The RBA has itself stated that the cash rate is expected to remain at 0.25% until 2023, at which point a new decision will be made.

However, we should compare the impact of this reduction in the cash rate to the last time Australia faced a possible recession. In response to the GFC, Australia cut its cash rate in 2008 from 7.25% to 3%, a 4.25% reduction. Compare this to the much smaller reduction of 0.50% in March this year.

This suggests that monetary policy will play a much smaller role in reducing the growth of unemployment, with fiscal policy being the main policy instrument.

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