Labour market outlook – October 2006

Background

This report provides an outlook for the labour market over the two years to March 2008. Our forecasts are detailed in the table on the following page, and a table of comparative forecasts is presented in the Appendix. This briefing is for your information.

Summary

The labour market outlook has remained largely unchanged since the set of forecasts made in June 2006, mainly because recent trends and the outlook for the economy have been fairly steady.

The only substantial change in our analysis is the incorporation of June 2006 quarter labour market and economic statistics and monthly migration data.  The main observation from the labour market data was the record high rate of labour force participation and the return to an equal record low unemployment rate.

A small reversal of recent labour market improvements is still forecast due to the slowdown in the economy.  However, the slowdown is now less than previously anticipated and unemployment is set to remain low.  We expect labour force participation to stay high, and small increases in labour productivity and net migration.

Economic growth expected to slow, but by less than previously expected

Economic growth slowed to an equal 5-year low of 1.9% in the June 2006 year, down from 3.0% in the June 2005 year.  New Zealand Institute of Economic Research (NZIER) Consensus Forecasts show economic growth is expected to ease further to 1.5% in the March 2007 year, although this figure has been revised up from 1.3% in the previous quarter’s estimate.

The decline in economic growth is driven by lower annual average growth in consumer spending as interest rates remain high and the housing market cools down.  Residential investment declined while growth in plant and machinery investment fell.  Offsetting some of this decline was a noteable rise in exports and continued government expansion.

In the medium term however, conditions are expected to improve.  This is in part based on the National Bank’s measure of firm’s own activity expectations.  NZIER Consensus Forecasts are now for economic growth to rise from a soft landing in 2006 to moderate growth of 2.2% in the year to March 2008 as the export sector continues improving (helped by a lower exchange rate, high commodity prices and growth amongst our trading partners).

Employment growth expected to ease over the next year

Annual employment growth was high at 3.0% in June 2006.  On a quarterly basis, employment growth has bounced back from no growth in the December 2005 quarter to report growth of 1.1% and 1.0% in the March 2006 and June 2006 quarters.

The strong employment growth in the first half of 2006 was surprising given slowing economic growth but could be due to firms filling longstanding vacancies (in anticipation of stronger future output growth) or labour hoarding.  This is reflected in a fall in average hours per worker to a near 20-year low of 34.1 in the June 2006 quarter.

Employment growth is expected to ease over the next year but still remain positive.  Following higher than expected growth in the first half of 2006, low growth is projected in the next three quarters, resulting in annual employment growth of 1.0% in the March 2007 year.  This easing in employment growth is in line with the slowdown in the wider economy since mid-2005. 

The weaker employment outlook is supported by the National Bank Business Outlook for September 2006.  It shows a net 1% of firms are expecting a fall in staff numbers in the year ahead, down from a net 6% expecting a rise in staff numbers at September 2005.

The industries that have made a significant contribution to economic growth over the past three years tend to be the most labour intensive.  These industries include construction and services such as health, education, wholesale, and retail.

The dependence on labour in these industries partly explains why growth in employment has been high relative to economic growth (ie growth in labour productivity has been modest).  A slowing in the domestic sector, especially construction and also wholesale and retail trade, is expected to reverse this effect over the next two years.

Employment has fallen in the last three years in the export sector, including agriculture, forestry, fishing, and manufacturing.  The share of employment in these sectors fell to a record low of 21% in the year to March 2006 but has since stabilised and is expected to rise in the next couple of years.

Labour productivity growth expected to improve

As described above, strong employment growth in labour intensive industries during a period of slowing economic growth has resulted in low labour productivity growth.  This can be explained by the lag in labour market adjustment to lower economic growth which in turn is due to firms filling longstanding vacancies or labour hoarding.

In terms of hours worked, economy-wide labour productivity growth is expected to be between 1.0% and 1.5% over the next two years.  The tight labour market, recent increases in wage costs and the recent wave of investment in plant and machinery will require employers to continue seeking productivity gains.

The export sector tends to be the most productive in terms of measured output per worker.  The forecast recovery in exports (lower

Net migration expected to increase slightly

Net migration inflows have risen strongly over the past 10 months from 6,000 in the year to October 2005 to 12,500 in the year to August 2006.  This increase has been driven by both growing arrivals and declining departures.

Net migration inflows are expected to rise slowly in the coming year.  This small rise is based on slightly more arrivals (the maximum number of new residents that can be approved for residence was raised by 500 to 52,000 for the year to June 2007) and a relatively steady outlook for departures.

Labour force participation and wage growth forecast to remain high

The labour force participation rate rose to an all-time high of 68.8% in the June 2006 quarter, up 1.1 percentage points in the last year.  Although a small decrease is expected from this record high as the population ages and job prospects ease, strong recent wage growth will continue to encourage people into employment.  Moreover, behavioural change has seen the participation rate of mature workers increased more than average over the last 5 years.  We forecast the participation rate to remain high at 68.3% in the March 2008 quarter.

Wage growth is likely to stay high in the year ahead given low unemployment.  Moreover, workers will seek higher wages to make up for the recent rise in consumer price inflation to a 6-year high of 4.0% in the year to June 2006.  Nevertheless, some easing is expected given the fall in skill shortages since late-2004 and a 1 to 2 year lag between skill shortages and wage growth.  

Unemployment rate expected to rise slightly from historic low

The unemployment rate reversed the previous quarter’s rise by falling from 3.9% in the March 2006 quarter to 3.6% in the June 2006 quarter.  This is the equal lowest since the HLFS began.

The forecast easing of employment growth is expected to lead to a rise in the unemployment rate.  However, the unemployment rate is still expected to remain low on a historic basis at 4.0% in the March 2007 quarter and 4.4% a year later.  Even with this increase, the expected unemployment rate would still be similar to that experienced in the tight labour market of late 2003.

The unemployment rate is particularly sensitive to the participation rate.  Keeping everything else constant, a change in the participation rate has a considerable impact on the unemployment rate.  With a 1% annual growth in employment, a participation rate that is 0.2% higher (ie 68.5% for the year to March 2007 instead of 68.3% as per our forecast) would see the unemployment rate rise to just under 4.3% instead of our current forecast of 4.0%.

Initiatives aimed at increasing workforce participation can therefore lead to short term increases in the unemployment rate.  The challenge will continue to be supporting the new labour market participants to take up job opportunities in growing sectors of the economy.