Transcript of Question & Answer Session Productivity, Wages and Prosperity

Thank you, governor. We have a microphone roving around the room that Sarah has. We have time for about four or so questions. We've got a media question as well and we'll do that as well. We'll start with some member questions. Can you just advise who you are and where you're from and don't ask the ‘When are rates going up?’ question.

Not for some time, I think would be my answer.

Sorry it's a two barrel one from two of my passions. The first is SMSFs. They've been pilloried about supposedly they've had a major contributor to the property boom but I'm wondering whether the Reserve Bank has done any modelling on the increased borrowing capacity of self-managed super funds behind that. And the second part of the question is a lot more general, is the Reserve Bank worried about some of the tightening credit that I can see is happening with small businesses as a result of the Banking Royal Commission and what that will do to the overall economy.

On self-managed super funds we haven't done any modelling, but our view has been that the self-managed super funds should not be able to borrow for property. That's our view. We haven't done any extra modelling. On tightening of credit conditions, are we worried about it? We're certainly noting that it's taking place. I think there's also a reduced demand for credit particularly in the residential area because prices are no longer rising, so people aren't trying to borrow to buy an asset whose price is rising. Turnover's down, there's less foreign demand, and so there's less demand for credit as well, and at the same time some tightening on the supply side. So we're just watching it carefully. I think at the moment it's manageable.

We shouldn't be too worried if credit growth slows down a bit. We've had many, many years in which credit growth was far in excess of our income growth and the debt-to-income ratio was rising all the time. It's probably in our longer-term interest for that ratio not to continue rising, and that means that there'll be periods where credit growth is a bit slower than income growth, and we may be heading for one of those at the moment, and I don't see it being particularly problematic.

Does the RBA include compulsory superannuation increases in wage growth data calculations, and if not, why not?

We don't do the calculations. We rely on data provided by the Australian Bureau of Statistics, and if you were to include the super contributions, I don't think it changes the basic story, which is that the current rate of wage growth isn't consistent with 2.5% inflation. From the central bank's perspective … my Board is supposed to deliver you an average rate of inflation of 2.5% over time. And I think there are good reasons why the government has asked us to do that. Low and stable, predictable inflation is in all of our interests, and something around 2.5% is what we're shooting for. We've done that for many decades and it's worked out very well. One of my concerns is that I'll have trouble delivering that for you if wage growth is only 2% and if you include super, it doesn't make any difference to that basic story.

So that's from my perspective at the central bank. But as an Australian, I worry more broadly about the consequences of just low nominal wage growth year after year, and the fact that many of the people who are lucky enough to live in our great country don't feel like they're sharing in the prosperity that many of us actually do enjoy. I think that's problematic, so from the central bank's point of view, it's a problem. I think from society's point of view, it's a problem as well. This is why I said a return to a world where wage increases start with a 3 rather than a 2 is in our national interest. It's certainly in my interest, and delivering you 2.5% inflation as well.

Can I just ask you a question? Which is why is productivity, you alluded to it, but why is productivity growth so low? What can we do to improve that? You alluded to it as well, but the productivity-wage-growth trade off, how do we get that working in sync again?

Well, why is it so low? I'm not sure it's so low. You can look at that graph that I had up before, and say, ‘Well, it's actually been okay over the last six or eight years.’ The last couple of years it's been weak. Those data are quite noisy, so I don't think you can yet draw the conclusion that labour productivity growth is unusually weak. What can we do? There is no silver bullet here that can fix it. What we've got to do is have a laser-like focus on making Australia an attractive place to invest and employ people.

And how do you do that? Well, it's the tax system, it's the way we design and price the infrastructure, it's the accumulation of human capital and training, and it's making sure that our markets are competitive. Because nothing spurs business to drive for productivity improvements like when their competitors are doing it. So they're the things we've got to work on. There's no single policy in any of those areas, but I think there are things right across the spectrum that we can be doing. Both business and government need to be focusing very squarely on how to make Australia an attractive place to invest and employ people and to innovate. How do you do that? I don't know.

You spoke quite a bit about tax policy and productivity, and I just wonder if the personal income tax cut plan outlined by the government in the budget, which there's been a bit of debate about, you feel is going to deliver the kind of consumer response that you're looking for? Is it the best way to achieve that? And also, given that there's been some criticism that you get a windfall revenue about once a decade if you're lucky, and we're having ours now after a decade or so … is this the best way - and I think it's a cost of about $140 billion over a period of years – is this the best way to invest that revenue windfall to get the sort of tax reform that would deliver the productivity boost that you're looking for and enable people to increase their wages? Thank you.

Well the tax cuts will certainly help with household budgets, and that will provide a small positive stimulus to household spending, which in the current environment is useful. I'm not sure that it constitutes the fundamental type of tax reform that would make a first order difference to the rate of productivity growth in the economy. It will help with household budgets, and I think that's what it's designed to do. It will also help with some of the work-leisure choices that people make. A bit more incentive to work because there'll be a higher return after tax from working extra hours, so from that perspective it's positive.

But, I think if you were starting from first principles and saying, ‘Well what kind of tax system do we have to make it very attractive to invest, employ people, and to innovate?’ You probably wouldn't design the system we currently have. It's a matter of pushing it in the right direction over time because the society doesn't have the appetite for the wholesale re-writing of the tax code, so it's kind of an incremental process of moving it. And this is one step in that process, but it's just one step.

Just on this point about wage growth and shared prosperity, do you think a lack of wage growth, is it contributing to a perception of inequality? Or do you think that's the actual effect that we're seeing?

I don't think the underlying issue for most of the community is that inequality is getting worse; it's the fact that their incomes are not rising at the rate they used to. People's incomes used to rise at 3.5% or 4% a year, and most people could look forward to that year after year, and they made their spending, and more importantly, their borrowing plans on the basis of that. And when they're only increasing at 2% percent a year, the debt burden that they took on when they thought their income was going to grow at 4% is more difficult to deal with, and so a lot of people are unhappy about that. And the aspirations they had for the growth in their incomes and their lifestyles aren't being met, and they're unhappy about that.

It has both a nominal and real component, because nominal income growth is low, but real income growth is low as well. For four or five years, real hourly earnings have not increased. Twenty-five years before that, we had a fantastic period where every year, real hourly earnings were rising at 1.5%, 2%, sometimes even faster than that. People got used to that, and it's not surprising when that's not happening anymore, we're all a bit unhappy. I think many workers see the economy doing quite well, see business profits very high, and they're wondering, ‘Where's their share in that?’ and ultimately, that's problematic for the society. It makes it more difficult to prosecute reform in Canberra and in the state capitals, and that's why I think it's in our collective interest as a country to get back to a world where people feel like they're sharing in the prosperity. It's in our long-run interest for that to take place.

What you describe with regard to productivity and the slowing of wages' growth coinciding with a significant increase in asset prices, homes, and debt burden seems reminiscent of what happened prior to the housing crisis in the United States 2007-2008. Maybe Australia is a little bit less extreme than the United States, but have you guys modelled what would happen if the housing market was to correct a bit more heavily and wages growth was to continue to be in a slow growth in Australia, what would be the kind of impact on the economy?

Well, I would take issue with your presumption that this is very much like what happened in the US. The really big difference, and the very important difference, is that lending standards have been tightened a lot in Australia in the last 4 or 5 years, so there has not been large-scale extension of credit to people who should not have got the loans, which is what happened in the US and I think that's the underlying source of their problems: very high leverage in complicated financial institutions on the back of making a lot of loans to people who shouldn't have got them. So that's very different to the situation that we face in Australia. With a bank system that's strong, it's resilient, and the credit standards have been strengthened. So I don't think that's a fair comparison.

Now, what happens when housing prices decline? As long as it's not a very large decline, I think this is manageable. We've had plenty of periods in the last two decades where housing prices in particularly Sydney and Melbourne have declined 10-12%. That's what happens in the housing market; you have these big run-ups, prices stabilise, sometimes they might fall, stabilise, and then they'll rise again. I think we're going through one of those events at the moment, particularly in Sydney and Melbourne. There's been a lot of additional supply come on to the market. The rate at which we're adding to the housing stock is the fastest in quite a few decades, so that extra supply at very high prices will bring prices back and that's what the market predicts will happen, and that's what's actually happening. I think this is manageable.

Remember, it wasn't that long ago that people were worrying about housing affordability. That was the number one political issue two years ago. House prices were rising too quickly, so we shouldn't fret just because house prices aren't rising at the rate that they used to, and even if they come down for a period before the next rise, that's okay. House prices in Sydney and Melbourne are still 40% up where they were at the beginning of 2014. So there's a lot of media coverage when house prices go down, but I think you've got to have a longer term perspective here, and the thing that gives me some comfort is the fact that the lending standards have been strengthened a lot over recent years. We haven't had the problems that the US have had.

One last one. I missed him all the way through, so I feel guilty.

You made a comment about business being split into leaders and laggards. Could you expand on that a little bit? Is it a cause of concern? And if so, what can be done to avoid that?

Well I don't know whether it's a cause for concern. It is a thing that's happened. The OECD has documented this very clearly that the productivity gaps between the leading firms in many industries and the average firm in those industries is unusually large. If you go back over decades, the productivity gaps are large, and the thesis which I find attractive is that the leading firms have worked out how to use the new technologies. There are big economies of scale, they've been able to get market share, and they're producing fantastic services at low price, and there are many other firms that are struggling to do that.

When they're struggling to do it, what do they do? Well, they try and use the new technologies, but the thing they can do is to control their costs. Because if you can't compete on the basis of having the very best technology, you've got to compete on costs. I think this is affecting the wage dynamics in many countries. Many firms feel like they have to compete, and how do you do it? You control your costs. It's an interesting question that we were talking about our table before is why is it that in so many labour markets now, firms are saying it's really hard to get workers. In Australia it's true; in the US it's true; in Europe it's true.

But they're not paying higher wages in the way that they used to. Why is that? And often when I ask business people why aren't they paying higher wages, they look at me as if I'm completely mad. ‘Why would we do that? You've got to understand, it's a very competitive environment out there. It's very hard, and there are a lot of reasons.’ I think it's linked, in an underlying sense, to technology and the struggles that many firms are having in identifying how to take advantage of new technologies. In time, we'll look back and we'll think this wave of technological progress that we're currently going through was a great enabler of higher living standards, but in the interim, it's making some people feel like they're losing out and the gains are unevenly distributed. I think it's a political concern, because if people feel like they're not participating in the gains here, and they're struggling, they get angry and that makes policy reform more difficult.

So we're going through a rough patch, but in good times. Could everyone please thank the Governor of the Reserve Bank, Phillip Lowe?