Unemployment: When is it good, and when is it bad? / by Adam Howard

Unemployment, terms of employment, having a job, getting a job, job creation or job losses are all SO HOT right now.

The media is in a flap, and are trying to get us all in flap about rising unemployment, which was at 6.4% Australia-wide in February 2015.

But then, all of a sudden, unemployment dropped to 6.3% in March.  What….?  I thought things were bad???   How come unemployment dropped when it’s meant to be rising?  End of the mining boom, slowing economy, falling interest rates, all that stuff.

Even my favourite and usually objective source of information, the ABC, got in on the act rolling out an executive recruitment specialist based in Sydney who commented he saw the trend in unemployment turning.

It’s all enough to make your head spin.  Just when you are used to a trend, even a bad one, someone tells you that’s changing.

This made me think about a few things:

1.       What’s a normal economy?

2.       How much unemployment is OK?

3.       How do you know how much unemployment is OK?

Firstly, I am going to disappoint everyone and say there is no such thing as a normal economy as every economy is in a state of constant change.  The best you can hope for is to categorise an economy as either benign or volatile, and at the moment Australia’s is actually fairly benign.  It’s a strange word, benign, so here’s a definition.

Benign:  having little or no detrimental effect; harmless.

That’s right…benign at the moment, and volatile during the boom.

But then, one of my pet hates is the talk in the media about “the economy”, as it seems pointless from an individual’s perspective to talk about a $1.6 Trillion machine; what it’s doing, who is driving it and what does that mean.

It seems more useful to talk about the little part of the economy within which a person exists.

We will get back to that later.

Let’s get back to me saying the economy is benign.  I said last week the mining boom hadn’t really been that good for Australia, and what I meant was it made our economy volatile.  What do I mean “volatile” within the context of unemployment?

First, let’s include a nice picture, with numbers too, so it’s easy to understand.

That’s Australia, but what about closer to home, here in WA?  Well:

So, in order to work out what level of unemployment is good or bad we need to back to economic theory for a second, where there are two terms to define:

  • Full employment: a state in which virtually all who are willing and able to work are employed.
  • The Non-Accelerating Inflationary Rate of Unemployment (NAIRU):  the specific level of unemployment within an economy that does not cause inflation to increase.

Full employment isn’t 0% unemployment as there are always people who, for one reason or another, are not currently employed.  The Organisation for Economic Cooperation and Development (OECD) estimates full employment in Australia to be somewhere between 3% and 4%.

Dropping unemployment means more economic activity as businesses need to hire extra staff to help produce more goods and services that are in demand.  This increase in demand for workers generally means wages will go up, and as wages go up and the demand for goods and services go up this turns into inflation. 

And as we all know, the RBA hates inflation.

NAIRU is the level of unemployment just above full employment where inflation isn’t being pushed up at an increasing rate due to rising wages, which are flowing from high demand for labour.

So, the sweet spot for an economy is to have unemployment within its own NAIRU band.  NAIRU changes based on how active an economy is and is also linked to the long term level of unemployment in that country.

According to the OECD Australia’s NAIRU band for the decade between 2002 and 2012 was between 5.5% and 6.5%.  For those looking for a riveting read, here is a link to the full report:

OECD Unemployment Report

So, in summary, any unemployment rates below 5.5% would be bad, not good.  It would push inflation up into the RBA’s red zone, plus other problems we will discuss briefly later.

Now, from our picture included above, Australia’s unemployment rate was below 5.5% for most of the 10 years between 2002 and 2012.

For the proof of this you only need to look at the cash rate, which the RBA uses as a tool to control inflation.  WARNING.  Graph ahead!!

The above line is almost an inverted version of the unemployment rate line from our first graph, wouldn’t you say?  In the lead up to 2008, as unemployment fell closer and closer to “full employment”, the RBA jacked the cash rate again and again to try to keep a lid on things.

Then BOOM!!!  GFC time…

Now, the level of unemployment just prior to the onset of the GFC; around 4%; is a double edged sword; a blessing and a curse.

The blessings are higher earnings, better terms of employment, greater wealth, an increased standard of living and more toys, oh, the toys….I saw of few of these appear in driveways.

The curses?  Laziness, a drop in productivity, less cyclical sectors of the economy having their workforces plundered, and, as I said above, those who should not be in full time employment being offered jobs.

While working for the WA Department of Commerce (back then it was called the Department of Consumer and Employment Protection) I spent some time in labour relations where I was investigating alleged breaches of labour relations legislation and met many of these poor folk when pursuing claims on their behalf.

I will not generalise, but I did encounter a large number of people with poor mental health and substance abuse problems and employers saying they had no choice as there was no one else.

And now where are we?  Well, Australian unemployment is at 6.3%, and WA unemployment is 6.1%, but both are trending upwards.

But, what’s bad on the high side? 

Famous economists from all schools of thought (from Keynes to Friedman) say that you have serious problems if you have 10% of the workforce out of work.

If Australia was to reach the number a further 500,000 workers would need to lose their jobs.  In a country of only 23 million people it doesn’t take a Nobel Laureate to work out that half a million people losing their jobs would be bad.

Is that likely?  No. 

For something to be likely, or probable, you need there to be a substantial probability that it could occur.  So, if we look a short period, say, just the past 20 years, there was about 2 years out of 20 where unemployment was over 10%, which equates to 10% of that period.  If we go back further, and look at the past 30 years, it still appears that the probability of unemployment being over 10% is about 10%.

So, not probable, but definitely possible.

And now I think I can comfortably say I have answered Questions 1. and 3. from the start of this week's Update, but not Question 2.  How much unemployment is OK?

We know below 5.5% is bad, and that 10% is bad.  The average unemployment rate for the 28 years from 1978 to 2015 was 6.91%, and the standard deviation was about 1.4% (statistically speaking, almost 70% of results will be within 1 standard deviation of the mean, or average).

That means 66.66% of the time Australian unemployment should fall between 5.5% and 8.3%.

I guess that's as close as we are going to get when trying to answer, "How much unemployment is OK?".   Anything between 5.5% and 8.3%.

Here is another little statistic that might help you feel better about jobs.  Obviously the sector being hurt the most right now is the resource sector. 

This sector directly employs about 277,000 Australians, so even if a third of sector employees were to lose their job, Australian unemployment would only increase from 6.3% to 6.9%.

That said, there are some crazy stories flowing from the resource sector right now about large corporate’s practices around getting rid of staff. 

Made me think about the George Clooney move “Up In The Air” where Clooney plays an HR gun for hire who flies around the US laying off staff.  Here’s a cool clip with Clooney and The Hangover’s Zach Galifianakis.

I just wanted to finish with an anecdote from a friend we will call The Renovator, who used to work for Anglo-Gold Ashanti Australia Ltd (AGA).

Staff at AGA’s head office in Perth were told a day prior that the next day there were going to be redundancies but were given no further information and it was assumed staff would just turn up treating the next day as “business as usual”.

At a particular time during the next day, all staff on The Renovator’s floor were told to stand next to their desk at a point close to their landline phone.  If their phone rang they were to answer and they would be given instructions to go to a certain floor to speak to HR. 

And so it began.

Phones rang one a time.  All other staff remained standing until roughly half the staff had gone…and were never seen again.

All remaining staff were told they could take the rest of the day off and that there was a bar tab provided for their use at The Lucky Shag at Barrack Street jetty.

They were then told to return to work the next day, not to discuss the redundancies and to treat everything as “business as usual.”

Food for thought….