Weak household income is being masked by an expansion in non-market care economy. The implications for productivity are often misunderstood, meaning the end of that transition could come as a shock to some.
Australian households have been hit by the largest real income shock since the Great Depression. And, although tax cuts and declining inflation boosted real incomes in the September quarter, other sources of income were weak. No wonder the spending response to those tax cuts was so anaemic and private demand has shown essentially no growth in recent quarters.
The RBA has been sanguine about this weakness in private demand. It assesses that aggregate demand has been outstripping aggregate supply, implying that a period of weak demand is needed to close the gap. In our view, though, the output gap has largely closed. The further deceleration in wages growth, unit labour cost growth and output price inflation in the latest quarter are all consistent with this.
The difference is that the RBA’s post-Review framework treats any deviation of inflation from target as a sign of a positive output gap. The Governor’s latest speech framed the assessment in this way: “Elevated inflation indicates that the level of demand in the economy is above the ability of the economy to supply the goods and services demanded.”
While this implicitly acknowledges that inflation expectations have been anchored, it does not adequately allow for lags in price adjustment or the fact that the usual year-ended calculation of inflation incorporates stale information. Nor does it make a distinction between stable above-target inflation and declining above-target inflation. While their models are more sophisticated than this, it seems something has been lost in an effort to simplify communications. Even more perplexing, the speech did not mention wages growth at all.
We also note that the concentration of growth in the public demand segment is part of a broader pattern where the non-market sector of the economy (health & social care, education and public administration – not all public sector) accounts for a larger share of the economy. Combined with growth in new public spending, at 2.2%qtr, outstripping the rest of the economy, these three industries accounted for the bulk of employment growth over the past year or so.
Baristas and care workers
This shift has several implications. First, strong growth in non-market sectors has only a weak link to overall price pressures, because their prices are not determined in markets.Second, taken together, these sectors generate less GDP or output per hour worked (i.e. labour productivity) than the market sector does. Arithmetically, as the share of non-market sector activity rises, measured economy-wide labour productivity falls, as we have previously highlighted. This is about more than different growth rates in productivity. In the transition, where the non-market sector’s share of the economy is rising, it is also a consequence of the differing productivity levels.
Third, measured aggregate productivity is further dragged down because measured labour productivity within the non-market sector has fallen, according to the annual national accounts. This is the result of the shifting mix of occupations within the ‘care economy’ towards relatively low-paid childcare and age & disability care workers – much like the ‘barista phenomenon’ we identified previously.
In the Q&A following her recent speech, RBA Governor Michele Bullock acknowledged that many of these additional workers are doing important jobs with significant positive spillovers for the rest of the community – teaching, nursing, caring for small children and the elderly. What was not acknowledged was that this period of weak demand and an apparently strong labour market may well be a transition phase. Instead, it is being interpreted as a signal that the trend in supply capacity is even weaker than previously believed.
This means that, when the RBA Board leaves the cash rate unchanged next week, it is also likely to keep its messaging similar to recent RBA communications. While there is an argument to pivot the language to signal that they are getting closer to the point of cutting rates, we do not expect that they will.
When the ramp-up ends
Further out, there is the question of what happens when the non-market part of the economy is no longer increasing as a share of the overall economy, which will happen sooner or later. To maintain overall growth, the market sector would need to see faster growth than it has recorded recently. However, historical experience suggests that when one or a few sectors are expanding their share at the expense of all the others, it takes a while before those other sectors’ growth rates bounce back.
The Australian economy could therefore be in for a period of even more subdued growth and much weaker employment than has occurred recently. And while we expect private investment to become a more prominent driver heading into 2026 – reflecting the need to expand capacity, transition to lower carbon emissions, and adopt new technologies – this may be slow to gain momentum.
It’s unclear how long this relative expansion in public demand will continue. Although the ABS reported that growth in NDIS spending was subdued in the September quarter, this and other programs might not have completed their ramp-ups. There are also risks around next year’s Federal election, both from additional boosts to public demand in the lead-in and potential changes flowing from the election outcome. In the short term, then, this shift might have further to run.
The risk is that a period of transition to a new economic configuration is misinterpreted as an ongoing trend. In that case, the shakeout once the transition ends could come as a shock.
