Brian Fallow: Workers: An endangered species

New Zealand is in danger of falling between two stools: unable to compete with low-wage economies for work and unable to compete with high-wage economies for workers.

During the past two years, twice as many New Zealanders left the country with the intention of staying away for at least a year as returned after spending at least a year away.

Net outflow to Australia was about 20,000 in each of the last two years.

The challenge of a globalised labour market is only going to intensify. The OECD projects a drop of 65 million in the working-age population across rich countries over the next 25 years as the population ages.

It is a dramatic turnaround from the past 25 years when the 45 million who retired were replaced by 120 million baby boomers.

The implications of this increasing labour shortage are sobering, given the gap in incomes which has opened up between New Zealand and its erstwhile peers.

Among other things, it is likely to mean a permanently, structurally, chronically tight labour market here.

We are already seeing evidence of that, and of employers' reaction to it, in recent data.

Even though we are two years into an economic downturn - gross domestic product growth has averaged a below-par 0.5 per cent a quarter for the past eight quarters - the unemployment rate is at a record-equalling low of 3.6 per cent and participation rates are at record highs.

Wage rates are rising at their fastest rate since the early 1990s, at least on an annual basis.

There is tentative evidence that the rate of wage increases may have peaked on a quarterly basis but it is too early to be confident of that. There may be a second wind as people respond to headline inflation rates of 4 per cent and the Reserve Bank's admission that it is likely to be late next year before inflation gets back inside its 1 to 3 per cent target band.

The data suggest hoarding of labour as employers, remembering how hard it has been to find especially skilled workers, are reluctant to shed people now, for fear that when business picks up, they will not be able to replace them.

On an annual average basis, the number of people employed has increased 2.5 per cent over the past year (almost all of it an increase in full-time employees) but the number of hours worked was only up 1.5 per cent.

Economic output over the same period is forecast to be up 1.8 per cent, implying a feeble lift in productivity to offset wage rises which at the median are running at 4.2 per cent.

So unit labour costs will be rising, leaving businesses either risking a loss of market share if they pass on those costs or seeing their profit margins squeezed.

While they last, labour hoarding and wage inflation help to insulate the household sector from harder times in the business sector - moderating but prolonging the downturn.

ANZ National Bank economists says labour hoarding is a sign of higher unemployment to come.

Their modelling found that a 1 per cent "excess" gap between numbers employed and hours worked typically translates into a 0.5 percentage point increase in the unemployment rate.

Firms are naturally keen to hang on to labour given the tightness of the labour market.

But they may be looking for an upturn in the economy too soon and underestimating the sustained period of weak growth needed to purge the inflationary pressures which built up over a long period of above-trend growth.

In addition, pressure on margins is likely to stiffen attitudes to costs.

"At some stage, businesses will no longer be able to hold on to their workforce, particularly if wage growth continues to be higher than productivity," ANZ economists say.

They question the conventional wisdom that strength in the labour market will continue to underpin the economy in general and consumer spending in particular.

They note that consumer spending is already "sedate" against the backdrop of continued gains in house prices and job growth. They wonder where spending will head if those pillars give way.

These cyclical issues need to be seen in the context of a structural shift to a tighter labour market.

Although the unemployment rate is expected to rise, few forecasters (if any) see it climbing back above 5 per cent in the foreseeable future.

Only a few years ago that would have seemed a low unemployment rate. Now nearly half of the OECD's member countries, including Australia, have unemployment rates below 5 per cent.

Which brings us back to the loud sucking sound of the brain drain.

In the year ended July, 47,400 New Zealanders left (for at least a year) offset by 24,100 returning (after at least a year away).

The net loss of 23,300 New Zealanders was unchanged from the year before and was offset by a net gain of 35,500 non-New Zealand citizens. That figure understates the contribution to the population and workforce from immigration, however, as many people later granted residency were classified as short-term visitors, not long-term migrants, in the airport arrival statistics.

A net gain of 12,000 people from migration does little to mitigate the effect of an ageing population on the workforce.

While the working-age population has grown by about 1.6 per cent a year on average over the past 15 years, the statisticians expect an average of only 1 per cent over the next 15.

Over the past five years, the labour force has grown by around 190,000, boosted by unusually high net immigration early in the period, and increasing labour force participation rates among men aged over 55 and women over 30.

Statisticians expect the labour force to nearly halve over the next five years and halve again over the five years after that.

From 2020, the number of people retiring from the labour force is expected to roughly equal the number joining it. So are there further gains to be made from reforms to the labour market or the welfare system?

Some, perhaps, but the low-hanging fruit has long been picked and it would take an elaborate cherry-picker to get at the rest.

The number of people on benefits in New Zealand is about half of what it is in Australia, adjusted for the relative size of the population.

The sheer size of the flows of people moving between employment and unemployment, and into and out of the labour force, suggests a flexible and efficient labour market.

The challenge for business is to focus on boosting capital expenditure and productivity - to switch the strategy from all hands to the pump to investing in a more efficient pump.