Reserve Bank of Australia governor Phillip Lowe has invoked memories of the 1970s, warning wage growth must be restrained to contain Australia’s surging inflation.

In the 1970s, Lowe said last week, “we got into trouble because wages growth responded mechanically to the higher inflation rate”. Now, with inflation above 5%, and tipped to reach 7% by the end of the year, he wants want people to keep in mind an “anchoring point” for wage growth of 3.5%.

That 3.5% represents the central bank’s long-standing judgement that wage growth equal to the RBA’s ideal inflation target (2.5%) plus productivity growth (typically more than 1% a year, currently above 2%) is economically sustainable.

Lowe says “if wage increases become common in the 4% and 5% range” that will make it harder to get inflation back to his target. But that prospect seems so remote it’s a wonder why he focused on it. Particularly when he said nothing about about the role of ever higher profits on increasing prices.

Wages increases aren’t the problem.

Nominal wage growth has languished well below that 3.5% benchmark since 2012. The last time wages grew at more than 4% was 2009.

Over the past decade, wages have fallen further and further behind the level implied by the RBA’s magic formula. During this time Lowe (governor since 2016) repeatedly cited weak wages as a key factor keeping inflation below the bank’s 2-3% target – but nothing happened.

So why is he now ringing alarm bells about wages growing too fast? It’s not at all clear when broad wage growth will even regain 3.5%, let alone surge faster.

The Fair Work Commission’s decision this month to raise the minimum wage by 5.2% and wages for other award-covered workers by 4.6% will boost the pay for about a quarter of workers. But even that can’t be considered “inflationary” by any stretch of imagination. In real terms, the minimum wage will fall again this year, as it did last year.

Most other workers have little chance of doing as well.

Wage gains from enterprise bargaining agreements (covering about 35% of workers) remain subdued. In the latest 12-month period they delivered an average increase of just 2.6%.

For the 38% of workers on individual contracts – now the most common pay-setting method in Australia’s individualised labour market – there is even less reason to expect wage growth to suddenly accelerate.

Profits have played a bigger role

Labour is not the only component in production costs: a considerable profit margin is also built into final prices. In fact, after decades of capital’s share of GDP increasing while labour’s declines, those profits have become more important in price-setting.

That’s a big change from the 1970s, when the narrative about wage-driven inflation became so firmly locked into the national policy discourse.

Indeed, by the end of 2021, corporations made 62 cents in gross profit for every dollar they paid in labour compensation. That’s the highest in history – and more than twice the rate in the 1970s.

Yet while the RBA warns darkly about rising labour costs, the growing importance of profits in driving higher prices is not mentioned. This reflects an ideological bias that wages are a “cost” item that must be tightly controlled, while profit is assumed to be a legitimate “reward” to businesses that efficiently supply the market with something valuable.

Calculating profit costs
The Australian Bureau of Statistics calculates several measures of unit labour costs – the cost of employing labour per “unit” of production. It does not publish a measure of “unit profit cost” – what gets paid in profit per unit of production. But perhaps it should. That might motivate greater attention to the role of profit margins in current inflation.

In lieu of ABS data, however, we can create a broad measure of unit profit cost by comparing the growth of nominal corporate profits to the growth of real output (similar to the methodology for measuring unit labour costs).

As shown in the following graph, since the start of the COVID-19 pandemic unit profit cost has surged 24%, compared with a 4% increase in the nominal unit labour cost (which, being over two years, is still below the RBA’s inflation target.

Blaming the victims
Warnings about wages misdiagnose the source of current inflation. They blame the victims of falling real wages for a problem they did not cause.

The RBA acknowledges the upsurge in inflation was initially fuelled by COVID-19 disruptions – including supply chain problems, global energy prices and major (but temporary) shifts in the composition of consumer demand.

But corporations with pricing power (particularly potent in sectors like energy, housing and groceries) took advantage of those disruptions to fatten their profit margins. They have profited from inflation, while workers lost out.

Now workers are being told they must swallow further real wage cuts to fix the inflation that enriched their employers.

Once the RBA confronts the issue of inflated profits as both a cause and a consequence of current inflation, we then might discuss labour’s role. Until then, workers are justified in fighting to protect their real incomes.