The true drivers of the cost-of-living crisis

The embattled head of the Reserve Bank, Philip Lowe, has lately changed the way he describes his great fear for Australia’s economy. He used to warn about a “wage-price spiral”, driving inflation even higher. Now he has turned that around and begun warning of a “price-wage spiral”.

A small semantic change, you might say, but it at least acknowledges that the primary driver of Australia’s persistent inflation problem is not wages. Still, Lowe and the RBA continue to insist more interest rate rises will be needed to combat inflation – albeit inflation caused by wages chasing prices, rather than prices chasing wages. They continue to warn of an incipient wages breakout, although the evidence suggests no such thing.

The truth is workers’ pay rose by just 0.8 per cent in the three months to December. This was significantly down on the preceding quarter’s increase of 1.1 per cent, and well below what the RBA expected. The annual rise was a modest 3.3 per cent.

Meanwhile, the cost of living continues to rocket upwards. Australian Bureau of Statistics data show the consumer price index increased by well over twice as much as wages – 1.9 per cent for the quarter and 7.8 per cent for the year.

The maths is simple and compelling: prices up 7.8, wages up 3.3, average worker 4.5 per cent worse off at the end of last year than they were at the beginning.

The RBA itself, in its February statement on monetary policy, said wage rises have “so far remained consistent” with its long-term inflation target. This week’s ABS data suggest that wage rises are moderating rather than accelerating.

There is no wage-price spiral, nor even a price-wage spiral. Some suggest Australia’s inflation now is increasingly driven by a profit-price spiral instead.

Senator Nick McKim is one of them. On February 7, when the RBA announced it was raising the cash rate again, for the ninth time in 10 months, the Greens Treasury spokesperson issued a statement demanding the Albanese government override the bank and reverse the increase.

The burden of high interest rates, he said, was falling most heavily on people who could least afford it: “mortgage holders, renters, workers and small businesses …”

At the same time, he noted, the sharemarket was at a near-record high.

“This blast of interest rate increases were never the right response to inflation driven by supply shocks and corporate profiteering,” McKim said.

He was absolutely right about the sharemarket. Having plunged at the start of the pandemic, it has since roared back. The ASX 200 is up about 60 per cent since March 2020.

Subsequent events have also lent strength to McKim’s other claim, about corporate profiteering driving inflation. Barely a week later, the Commonwealth Bank reported a record profit of $5.15 billion for the six months to December.

The bank announced it would sharply lift its payout to shareholders – giving them an interim dividend of $2.10 a share, an increase of 35 cents on the prior corresponding period – and would buy back an extra $1 billion worth of its own stock.

All up, the Commonwealth Bank boasted almost $22 billion in dividends and buybacks over the past two years.

Australia’s biggest bank made no pretence of claiming its performance was all the result of better serving its customers. Rather, it implicitly acknowledged it was screwing them, saying that its inflated bottom line was in large measure “driven by a recovery in net interest margins in the rising rate environment”.

Put another way: as the central bank lifted official rates, the CBA took advantage by jacking up the amount it charged its borrowers more than what it paid its depositors.

A day later, another of the Big Four banks, National Australia Bank, announced record half-year earnings of $2.15 billion. NAB’s chief executive, Ross McEwan, also acknowledged that the “higher interest rate environment, resulting from central bank actions to curb inflation, has benefited our revenue this period”.

The good news for bank shareholders is not only bad news for bank customers but also for the RBA’s efforts to rein in inflation. Even as the central bank keeps ratcheting up official rates in an effort to take demand out of the economy, those shareholders are getting billions of extra dollars to spend.

It’s not only the banks that appear to have used the cover of inflation to fatten their bottom lines and shareholders’ wallets, either. This week saw Australia’s two biggest retailers, Coles and Woolworths, who between them account for about 70 per cent of the grocery trade, among other things, announce bumper profits.

On Tuesday Coles reported a $643 million profit for the six months to December, up 17 per cent on the corresponding period the previous year. On Wednesday, Woolworths announced its profit for the half-year was $907 million, up 14 per cent.

Then there’s Qantas, which on Thursday announced a $1.43 billion profit for the half year.

During the pandemic, the airline benefited to the tune of some $2.3 billion from a Morrison government bailout. At the time, the Transport Workers Union advocated that instead of just giving the airline money the government should have taken an equity stake. Many other governments did that when their airlines were struggling.

Had we done the same, a share of Qantas’s current super-profits, which incidentally have been built by charging passengers high fares and are another contributor to inflation, would have flowed to taxpayers.

Oddly, while the Reserve Bank continually raises the spectre of excessive wages driving up inflation, for which there is so far no evidence, it has had little to say about excessive profits, for which the evidence is mounting.

The bank said “supply shocks” accounted for between half and three-quarters of the rise in inflation. These included the war in Ukraine, “other global supply disruptions resulting from the Covid-19 pandemic, and domestic supply disruptions from poor weather”.

Much of the rest it blamed on “strong domestic and global demand … reflecting the rapid economic recovery following the significant fiscal and monetary policy responses to the pandemic”.

This amounts to a tacit admission that they and the previous government erred by overstimulating the economy. It was a common mistake around the world, says Warwick McKibbin, professor of economics at the ANU Crawford School and a former RBA board member.

Central banks kept interest rates too low for too long and pumped out money. Governments spent up big on Covid relief packages for business owners, workers and consumers.

“So, you’ve got this big injection of liquidity, a big expansion of government [spending], you’ve got contraction of supply … too much liquidity chasing too few goods. Of course you’re going to end up with inflation,” McKibbin says.

There are a number of ways to cool an overheated economy. The government could, for example, slash its spending or increase taxes or bring in price controls.

But, with the sole exception of its imposition of price controls on the worst price gougers, the energy sector, the government hasn’t taken these approaches.

(It’s worth noting here that fossil fuel companies and the Coalition parties loudly objected that these price controls would cripple the industry. It is also worth noting that the oil and gas company Santos reported a 221 per cent increase in its full-year profit this week, despite production going up just 12 per cent.)

Instead, says McKibbin, the government has sought to make the RBA the “scapegoat”, wearing the blame for wielding the only tool it has to control inflation: interest rates.

“This is not a new phenomenon,” he says. “People have been dumping everything on the Reserve Bank as a policymaker of last resort for a long time. It’s got worse since I left.”

He has considerable sympathy for Philip Lowe. At least he has owned its errors, McKibbin says, unlike the politicians.

“Actually, I would say the one person who does have integrity in this whole argument is the [RBA] governor. But he shouldn’t be smiling when people are asking him questions in parliamentary hearings, because that just sends a really bad signal to people who are out to get him.”

Among those parliamentary questioners – although not one out to get Lowe last week – was Allegra Spender, the new independent member for Wentworth, businesswoman and Cambridge University-educated economist. She also has sympathy for Lowe and the difficulty of his task, particularly given the inflation spike is a combination of supply-side and demand-side forces.

She is critical of the government for not doing enough to help the bank. “The government has a role in fiscal policy,” she says. “Are there areas of spending that could be put off? I think they should absolutely be looking very carefully to say, you know, even if it’s an election promise, is this the year to deliver it or will we have to deliver it at a later time?”

Asked what other measures government should take, she says: “I asked [Lowe] that very question and he made the fair point the government levers can be much slower to act, and harder to politically get through. If you tried to change tax rates monthly, for example, you can imagine the furore.”

Spender supports the government’s intervention in the energy market, and also a broader review of taxes and tax breaks, particularly as they apply to the resources sector. That would not help the immediate problem, or course, but should be done nonetheless.

There is no shortage of other suggestions. Nicholas Gruen, chief executive of Lateral Economics, has previously suggested an independent body, like the RBA but with broader powers, should be established to operate essentially a floating tax rate that could change with the economic circumstances. He suggests it would work something like the current Medicare levy.

We have seen something similar before. In the 2014 federal budget the Abbott government introduced a temporary budget repair levy under which people with a taxable income of more than $180,000 paid an additional 2 per cent tax. The difference in Gruen’s proposal – in which some government figures have expressed interest – is that the levy would not be determined by government.

Gruen also suggests workers could be required to put extra money into superannuation during times of high inflation. That would reduce consumption in the short-term, while better providing for retirement.

Last year the International Monetary Fund suggested another way to fight profit-driven inflation by taxing so-called “economic rents” or super-profits. The idea has many other advocates, including McKim, who also argues for a wealth tax.

What the ideas all have in common is that they are better targeted than interest rates, which inevitably fall most heavily on the people at the bottom.

Andrew Leigh, an academic economist before becoming the Labor assistant minister for Competition, Charities and Treasury, says the current inflation crisis has served to highlight a pre-existing problem in the Australian economy: lack of competition.

“We know that over the last couple of decades, Australian markets have become more concentrated,” Leigh says.

“There’s been also a significant increase in mark-ups, which are the gaps between costs and prices. Mark-ups have risen considerably over a decade in which wages in real terms fell and productivity flatlined.

“The lack of market dynamism is a problem for economic growth more broadly. But it’s also a problem for consumers right now. It’s easier to take advantage of a situation when there’s fewer companies in the market.”

Rod Sims, a former chair of the Australian Competition and Consumer Commission now with the ANU Crawford School, elaborates on Leigh’s point:

“There is no doubt that concentration in the Australian economy, which is huge, is contributing to the inflation.

“If you think about the main categories of consumer spending, a considerable number of them are very concentrated.

“We’ve got two main supermarkets, we’ve got three main energy retailers, we’ve got three telecommunications players, and we’ve got four banks, which basically move in unison, which affects your mortgage.”

Too many economists, Sims says, “assume competition and assume rapid industry response to changes in costs”.

This is not the case. “They’re just not factoring in the fact that the companies can increase their profit margins. I think that is a real issue.”

Meanwhile, says McKibbin, the Reserve Bank spends far too much time worrying about workers’ pay.

Even if wages were to increase faster, he says, it would have a much smaller impact on inflation than the RBA thinks.

This is because the share of labour in Australia’s gross output of goods and services has been wildly overestimated. The RBA assumption is that when Australia produces something, labour accounts for 65 per cent of the inputs and capital accounts for the remaining 35 per cent.

In fact, in the globalised world, where so much of the inputs into what we produce comes from elsewhere, domestic labour only accounts for about 18 per cent of inputs.

“So,” McKibbin adds, “you can get 82 per cent of inflation coming from things outside the labour market.

“In the bigger picture of what’s driving inflation, it’s not labour.”