Wages, productivity and competitiveness

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January 8th, 2015

Over the last few years, one of the good pieces of economic news has been the improvement in competitiveness observed in the Spanish economy. Spain's unit labour costs (ULCs) compared with its trading partners in the euro area (the most widely used benchmark to analyse the trend in price competitiveness) are already at the levels of the 2000s. However, now that economic activity is starting to pick up, the question is whether competitiveness has improved  thanks to temporary factors related to the economic cycle or whether this improvement comes from a fundamental change in Spain's economy. A brief analysis of the factors underlying the trend in ULCs offers some interesting  pointers.

Between 1999 and 2007, nominal compensation per employee for the economy as a whole rose significantly (3.5% annually on average), far greater than the rise in productivity (0.3% annually). As a result, ULCs increased substantially (see the second graph), much more than the increases recorded by Spain's trading partners, thereby reducing its competitiveness.1 By sector, wage increases and productivity improvements did not appear to be related in any way. In other words, during this phase, compensation generally grew to a similar extent in all sectors irrespective of the gains in productivity occurring in each of these (see the third graph).

This pattern changed significantly during the recession. Initially the higher fall in employment compared with the drop in GDP meant that productivity increased considerably, pushing down ULCs. As from 2010 a much more contained trend in wages was added to this process and, as can be seen in the second graph, this second factor also played an  important role in reducing ULCs. In addition to wage containment, which appears to be relatively widespread in all  sectors, the process used to establish compensation also seems to have changed: since the start of the recession it has been more in line with the trend in productivity in each sector. This is shown by the third graph where we can see that wages have risen the most in precisely those sectors whose growth in productivity has been the highest while wage rises have been more limited in those sectors seeing a smaller increase in productivity.

This closer relationship between the trend in wages and productivity suggests that the changes occurring in the system used to establish employee compensation are fundamental and should therefore continue over the coming years. And it is important for this to be the case as they are essential for the Spanish economy to successfully tackle the big challenges it still faces: to continue improving its competitiveness to ensure current account surpluses that help to reduce its external debt, as well as to increase the pace of job creation.

1. Productivity of the labour factor is the quotient of gross value added in constant terms (GVA) divided by employment equivalent to full-time (EETC): GVA/EETC. Unit labour costs (ULCs) are the quotient of nominal compensation per employee (w) divided by productivity (GVA/EETC). We use the concept of nominal compensation per employee instead of real wages due to the difficulty of obtaining price indices by sector.