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Unit Labor Costs in the Eurozone: The Competitiveness Debate Again


Jesus Felipe


Asian Development Bank

Utsav Kumar


Asian Development Bank

March 1, 2011

Levy Economics Institute of Bard College Working Paper No. 651

Abstract:     
Current discussions about the need to reduce unit labor costs (especially through a significant reduction in nominal wages) in some countries of the eurozone (in particular, Greece, Ireland, Italy, Portugal, and Spain) to exit the crisis may not be a panacea. First, historically, there is no relationship between the growth of unit labor costs and the growth of output. This is a well-established empirical result, known in the literature as Kaldor’s paradox. Second, construction of unit labor costs using aggregate data (standard practice) is potentially misleading. Unit labor costs calculated with aggregate data are not just a weighted average of the firms’ unit labor costs. Third, aggregate unit labor costs reflect the distribution of income between wages and profits. This has implications for aggregate demand that have been neglected. Of the 12 countries studied, the labor share increased in one (Greece), declined in nine, and remained constant in two. We speculate that this is the result of the nontradable sectors gaining share in the overall economy. Also, we construct a measure of competitiveness called unit capital costs as the ratio of the nominal profit rate to capital productivity. This has increased in all 12 countries. We conclude that a large reduction in nominal wages will not solve the problem that some countries of the eurozone face. If this is done, firms should also acknowledge that unit capital costs have increased significantly and thus also share the adjustment cost. Barring solutions such as an exit from the euro, the solution is to allow fiscal policy to play a larger role in the eurozone, and to make efforts to upgrade the export basket to improve competitiveness with more advanced countries. This is a long-term solution that will not be painless, but one that does not require a reduction in nominal wages.

Number of Pages in PDF File: 32

Keywords: Competitiveness, Eurozone, Income Distribution, Unit Labor Costs

JEL Classification: D31, D33, E25, J30

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Date posted: March 3, 2011  

Suggested Citation

Felipe, Jesus and Kumar, Utsav, Unit Labor Costs in the Eurozone: The Competitiveness Debate Again (March 1, 2011). Levy Economics Institute of Bard College Working Paper No. 651. Available at SSRN: http://ssrn.com/abstract=1773762 or http://dx.doi.org/10.2139/ssrn.1773762

Contact Information

Jesus Felipe (Contact Author)
Asian Development Bank ( email )
6 ADB Avenue, Mandaluyong City 1550
Metro Manila
Philippines

Utsav Kumar
Asian Development Bank ( email )
6 ADB Avenue
Central and West Asia Department
Mandaluyong City
Philippines
HOME PAGE: http://works.bepress.com/kumarutsav/
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