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The Flawed Economics of Cutting Penalty Rates

by Jim Stanford on August 12, 2016
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Penalty rates for working on weekends were an important “sleeper” issue in the recent federal election in Australia.  On the surface, both Labor and the Coalition agreed the future of penalty rates would be determined by the Fair Work Commission.  But that superficial consensus couldn’t hide deep differences in what the respective parties were actually hoping for.  Labor explicitly urged the FWC to maintain existing penalties: double-time on Sundays, and time-and-a-half for Saturdays.  Many Coalition candidates, on the other hand, endorsed a reduction in penalties – consistent with the views of business lobbyists who want lower operating costs on weekends.

At the grass-roots level, meanwhile, the issue resonated strongly with significant numbers of voters.  Union activists launched an 18-month “Save Our Weekend” campaign, knocking on tens of thousands of doors in marginal seats before the election was even called.  Opinion polls showed strong support for retaining (or even increasing) weekend penalty rates; respondents opposed cutting penalties by two-to-one margins, or more.  The swing against the Coalition in ridings targeted by the penalty rates campaign was nearly twice as large (6 percentage points) as the national swing.

Penalty rates will remain a charged issue in the political arena.  But for now, the main attention shifts to the Fair Work Commission (FWC), whose decision is expected in coming weeks.  The Commission should reject the entreaties of retail and restaurant employers for lower penalties, because the economic case for cutting penalties looks shakier all the time.

Employers in all sectors routinely claim that cutting wages will strengthen job-creation.  But this purported trade-off between compensation and employment is refuted by macroeconomic evidence.  Indeed, historical data suggest higher wages are more often associated with stronger employment outcomes, not weaker: in part because household consumption spending (which depends directly on wages) is crucial for overall spending power and hence economic vitality.  The retail and hospitality industries have been the most aggressive advocates of weaker penalty rates.  Yet ironically, it is in these sectors that the argument for wage-cutting is weakest of all.

After all, employment in stores and restaurants depends directly on the level of consumer spending.  And this demand constraint is more binding in domestic service sectors than any other part of the economy.  In export-oriented industries, employers can at least pretend that lower labour costs will boost sales (by undercutting foreign competition and hence winning new business).  Even here the argument is not convincing, since in practice global competitiveness depends more on productivity, quality, and innovation than on low wages.  But in non-traded domestic sectors, where Australians produce services for other Australians, the logic falls apart completely.

Remember, Australian consumers already spend far more than they earn.  That’s why average consumer debt is growing rapidly: now equal to 125 percent of national GDP.  How could making it less costly for shops and cafes to open on weekends, somehow unleash new reservoirs of spending power, and stimulate tens of thousands of new jobs?  In macroeconomic terms it’s simply not possible.

Keeping businesses open for longer hours on weekends, doesn’t mean consumers have more money in their wallets.  Instead, the same amount of retail and hospitality spending must now be spread across longer opening hours.  If anything, that hurts productivity and profitability, and will eventually lead to the closure of some retail and hospitality firms that were already operating on the financial edge.

It’s the same reason why opening a new shopping mall cannot, on its own, increase total employment levels.  Unless there are other factors driving an expansion in broader incomes and spending, opening one store must inevitably lead to a closure somewhere else.

It’s especially laughable to hope that cheaper weekend labour could somehow attract new business to Australia’s stores and cafes.  Are penalty rate opponents expecting a surge in tourists from China, perhaps – who were just waiting for cheaper Sunday shopping before booking their trips?

In short, the very industries pushing hardest for reduced penalties – retail and hospitality – are the ones most dependent on the spending power of domestic consumers.  Hence they would directly experience the most economic blowback from their own wage cuts.

Indeed, there is abundant evidence that unprecedented stagnation in wages is already undermining growth and job creation.  Nominal wages are inching along at their slowest pace in recorded history (barely 1 percent per year).  Real wages, adjusted for inflation, have been falling since 2013.  Economists of all persuasions have highlighted the resulting weakness in household incomes as a key factor behind sluggish growth, rising personal debt, and unemployment and underemployment.

Ultimately, rolling back penalties would simply constitute a major effective wage cut for workers who are already among the worst-paid in society.  It will exacerbate the broader wage stagnation that is holding back Australian growth.  And it will whet the appetites of other employers for more wage suppression – now on grounds of “keeping up” with the advantages granted to retail and hospitality.

Australia needs higher wages, not lower.  Let’s hope the Fair Work Commission sees this big picture.

Jim Stanford

Jim Stanford is a Canadian economist, recently arrived in Sydney. He worked for over 20 years as economist for the Canadian Auto Workers union (and its successor organization, Unifor), and is the author of Economics for Everyone: A Short Introduction to the Economics of Capitalism (second edition published in 2015 by Pluto Books in the U.K.). Jim now works for the Australia Institute, as Economist and Director of its new project, the Centre for Future Work. He is also an Honorary Professor in the Department of Political Economy at the University of Sydney.

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