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1,Wage Competitiveness in Luxembourg.,Stefan Collignon and Piero Esposito,A Study engaged by the Government of the Grand Dutchy of Luxembourg,In respect of the Project,Wage Imbalances in the European Labour Market.,London, 29 September 2016,2,Contents,Introduction. 3A new measure for wage cost competitiveness. 5Aggregate values and comparison with other EU countries. 8Sectoral breakdown. 11Conclusions. 17Annex - Equilibrium wages for selected manufacturing industries and Trade and repairs. 19Works Cited. 19,Abstract,We propose a new method for estimating the competitiveness of wages in levels and not as usually done byunit labour indices. We define a new measure for equilibrium wages and find that overall theaverage labour cost level in Luxembourg was nearly 30.000 per year below this equilibrium.,We then analyse sectoral wages. It appears that the competitive advantage in Luxembourg isconcentrated in ITC, financial and public administration sectors. The manufacturing sector seemsto be handicapped when compared to the average return of the Luxembourg macro-economy, butwhen it is compared to the European manufacturing sector, it is very close to equilibrium.,We conclude by asking some questions about the future evolution of the Luxemburg model.,3,Introduction,The debate about the competitiveness of member states in the Euro Area has become moreintense, and more controversial, since the Global Financial Crisis and the subsequent Euro crisis.Improving competitiveness is often seen as synonymous with wage cuts and austerity. However,lower wage costs do not always improve competitiveness. First of all, competitiveness canimprove even when wages are rising, provided productivity improves as well. Second, whenausterity reduces effective demand, productivity will slow down and this may cause adeterioration of competitiveness. Hence, assessing an economys labour cost competitivenessrequires a more comprehensive analysis that integrates wage bargaining with productivity andgrowth theory.,Measuring wage competitiveness is difficult. Eurostat produces a number of indicators based onnominal and real unit labour costs and compares them to other countries or country groups, buttheir informational content is uncertain and even sometimes contradictory. Figure 1 shows theunit labour cost (ULC) indices for Luxembourg and its immediate neighbours France, Germany andBelgium as published by the European Commissions AMECO data base. All time series are basedon the year 2010. It looks as if nominal unit labour costs have increased much more rapidly inLuxembourg than in neighbouring countries since the start of European Monetary Union in 1999.Hence, one would conclude that the Grand Duchy has lost competitiveness against the 16 mostimportant EU member states and against 34 industrialized countries. By contrast, Germany andthe Euro Area in general seem to have improved their relative positions. After the financial crisis in2008, wage increases have slowed down. In nominal terms the competitiveness loss forLuxembourg relative to the Euro Area is similar to most neighbouring countries, although Germanwages are now increasing much faster. However, when we look at real unit labour costs, which arethe same as the wage share, the picture is inverted. If we discard the peeks and shocks of thefinancial crisis, there is a broad improvement in the labour cost competitiveness of Luxembourgbecause the wage share has fallen and the profit share has increased. So which index gives abetter picture of these competitive developments?,In this paper we look at a new method for assessing the competitiveness of labour costs in theEuro Area and apply it to the case of Luxembourg. We define a new measure for equilibrium wagelevels and find that overall the average labour cost level in Luxembourg was nearly 30.000 peryear below this equilibrium. This is dramatic. We then analyse sectoral wages. It appears that thecompetitive advantage in Luxembourg is concentrated in ITC, financial and public administrationsectors. The manufacturing sector seems to be handicapped when compared to the averagereturn of the Luxembourg macro-economy, but when it is compared to the Europeanmanufacturing sector, it is very close to equilibrium. We conclude by making some suggestionshow to deal with this situation.,Figure 1. Nominal and real Unit Labour Indexes (2010=100). Absolute and relative measures.,Source: own elaboration on Eurostat4,12011010090807060,92,94,96,98,00,02,04,06,08,10,12,14,16,Nominal ULC,110.0107.5105.0102.5100.097.595.092.590.0,92,94,96,98,00,02,04,06,08,10,12,14,16,Real Unit Labour Costs,858075,110105100,92,94,96,98,00,02,04,06,08,10,12,14,16,Nominal ULC relative to 16 EU countries,95.092.590.0,102.595100.09097.5,110.0107.5105.0,92,94,96,98,00,02,04,06,08,10,12,14,16,Real ULC relative to 15 EU countries,1401301201101009080,92,94,96,98,00,02,04,06,08,10,12,14,16,Nominal ULC relative to 34 industrial countries,1061041021009896949290,92,94,96,98,00,02,04,06,08,10,12,14,16,Luxembourg,EA17,France,Germany,Belgium,Real ULC relative to 37 industrial countries,A new measure for wage cost competitivenessThe trouble with measuring labour cost competitiveness by ULC indices as in Figure 1 is thearbitrariness of the base year of the index. Because we do not know whether a particular economywas in equilibrium in the base year, this can lead to misleading judgements if the index indicatesrapid increases, when the country started out from an undervalued or overvalued position. Wetherefore need a benchmark for wage levels and not for the wage dynamics.Starting with the simple assumption that in a market economy competition allocates capital towhere it generates the highest return so that in equilibrium the rates of return on capital ought tobe at the same level, we define the equilibrium wage as the total labour compensation level, atwhich the average return on the capital stock is equal to the average return in the Euro Area as awhole. We will calculate this relative return with respect to the economy of Luxembourg as awhole, or for given sectors such as manufacturing or financial services. It is important toemphasise right from the beginning that this equilibrium wage is a benchmark derived fromcapital market theory, and does not reflect a labour market clearing equilibrium wage. However,there is no automaticity that the equilibrium prevails in the short run, as the Varieties ofCapitalism literature (Hall, Peter A. und David Soskice, 2001) has demonstrated.The gross return on capital is the ratio of non-wage value added relative to the historic value ofthe aggregate capital stock of a country or sector. It also includes the part of value added that isused to substitute the consumed capital. In order to obtain a measure of net return on capital,which is what matters from the point of view of an investor, consumption of fixed capital (cfc) issubtracted from non-wage value added.,(1), =,Where PY is nominal GDP, w is average wage compensation, L is the employment level, Pk is thecapital stock deflator and K is the capital stock in constant prices. We also define nominal labourproductivity as nominal output per person employed,(1b), =,By multiplying and dividing equation (1) by nominal GDP, the return on capital can be expressed asthe product of the net capital share and the average capital efficiency (ACE):,(2), =, ,= ,Where k is the net capital share and ACE is the ratio of nominal GDP to nominal capital stock.Our equilibrium condition is that a countrys or sectors net return on capital is equal to theaverage level in the Euro area:5, =, , ) = (1 , ) ),Unit labour costs are defined as the wage costs per unit of output: =, =,=,= ,See: (Stockhammer, 2015),= . Hence real unit labour costs are,6,(3), = ,The equilibrium wage share of a country or sector is then:,(4),=1,The wage share is identical with real unit labour costs,1 so that equation (4) also represents acountrys equilibrium real unit labour costs. Thus, if a countrys capital productivity is higher than,the average European capital productivity, so that,< 1, its equilibrium wage share (and,therefore in equilibrium a countrys real unit labour costs) will be above the Euro Areas. This is thesame as saying that a larger share of value added can be used to remunerate labour becausecapital is more productive. On the other hand, if in some countries the labour share has fallen overtime, this may simply reflect lower capital productivity. Assuming equilibrium as a startingposition, voluntarist increase in wages, as suggested by wage-led growth theorists,2 would onlygenerate deviations from equilibrium and harm competitiveness.We can now solve equation (4) to obtain the equilibrium nominal wage level w*:, (1 ,(5)where =, = = (1 ,It is clear that the equilibrium wage so defined is a function of the average wage share in the EuroArea, national or sector specific labour productivity and the relative development of nominalcapital productivity, i.e. relative prices of goods and capital and the national (or sectoral) capital-output ratio relative to the Euro Areas. An additional factor is the consumption of fixed capital,but this depends on the level of economic activity and on the nature of the capital stock, hence wecan consider it as derived from the other variables in the equation. Nevertheless, because thedestruction (write-off) of capital during a crisis may cause significant reductions in equilibriumwages, as is evident from Figure 2 (cf. 2000 and 2008-9), equilibrium wages can be rather volatile.To measure competitiveness, we will match the actual labour compensation against theequilibrium wage. We calculate an index of relative competitiveness as a ratio and show absolutecompetitiveness as the gap between actual and equilibrium wages. If actual wages are higher thanthe equilibrium wage, the return on capital in a particular country or industry will be lower thanthe Euro-average. We interpret this as a competitive disadvantage, for lower profitability is likelyto deter investment until the return on capital is improved, while highly competitive sectors andcountries would attract capital and boost economic growth until over-accumulation reduces thereturn. Hence, wage cost competitiveness depends on actual wages as they emerge from wage, ,12,See (Koll, 2005) (Commission, 2005),7,negotiations and on structural factors that shift the equilibrium wage. It also depends on theaverage wage share of the Euro Area, i.e. on how aggregate wages develop relative to inflationand productivity in the Euro Area as a whole. If a particular region or industry deviates from theaverage performance, it will gain or lose competitiveness. This means that if wage increases areslowing down in the Euro Area as a whole, all countries will have to follow suit if they wish toremain competitive. This was the case during the first decade of Monetary Union, as Figure 1shows, because German wage restraint kept the average wage costs in the Euro Area down,although this has changed during the Euro Crisis.,Our concept of equilibrium wage defines the limits for wage increases that are consistent forstimulating demand and pursuing a wage-led growth strategy. The famous Rehn-Meidner rulerecommended that nominal wages ought to increase at the rate of labour productivity plusinflation, so that the wage share remains constant. In the Euro Area that has been amended to saythat wage increases should take into account labour productivity and the inflation target of the,ECB.3 However, this rule ignores the impact of capital productivity on equilibrium wages. Balanced,growth across countries and sectors would require that nominal wages are equal to equilibriumwages.,As equation (5) shows, the effect of capital productivity on equilibrium wages is far from trivial.Even if all countries had exactly the same rate of nominal wage increases in line with the Rehn-Meidner rule, their competitiveness could still be distorted by diverging capital productivitydevelopments. Such divergence may be a consequence of broad country-specific factors, such asinfrastructure, R&D, skill building, etc., but it may also reflect different weights of economicsectors with diverse capital-output ratios. For example, it is well-known that productivity is morelikely to improve in manufacturing than in most service industries, so that an industrial hub likeGermany is prone to reap larger competitive advantages than service intensive economies. Forthis reason, it is important not only to analyse aggregate but also sectoral equilibrium wages.,3,Lehman,Aggregate values and comparison with other EU countriesFigure 2 shows the evolution of wages costs in Luxembourg. Actual wages are structurally belowthe equilibrium level and the comparative advantage has increased after the Global Financial Crisiand during the Euro crisis. Actual wages are more stable than the equilibrium wage, which reflectschanges in capital productivity, as we will explain below.Figure 2. Luxembourg: actual and equilibrium wage10090807060504030,96,98,00,02,04,06,08,10,12,14,16,Average wage (Compensation per employee)Equilibrium wageSource: own elaboration on STATEC, Eurostat.Figure 3 shows the competitiveness index, defined as the ratio of actual to equilibrium wagelevels, for the aggregate economies of Luxembourg, France, Germany and Belgium. With smalloscillations, wages in Luxembourg have kept a stable gap of 30 percent below equilibrium for thelast 20 years. This is different for the neighbouring economies. In Germany, wage costs were 12%above equilibrium in 2000, but have since fallen below equilibrium stabilizing around minus 4%. Bycontrast, France has lost its initial competitive advantage of 6% below equilibrium and is now 6%above. Thus the shifts in competitiveness are a deterioration of 12% in France and animprovement of 16% in Germany since monetary union started. In Belgium, wage levels havestabilized slightly below but close to equilibrium.8,
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