An Economic Analysis of the Wage/Productivity Disadvantage

John R. Brock, Ph.D., Vice President

... As labor productivity rises, wages tend to rise as well.  But what happens if wages rise considerably faster than productivity?  Or, put differently, what happens if workers are paid more than the value they produce?  Examining the economic situation in Europe may provide an answer.  In the Summer 2015 issue of the Journal of Economic Perspectives, economist Christian Thimann argues that “there are two main problems holding back private sector employment creation in the stressed eurozone countries …  First, there is a persistent competitiveness problem due to high labor costs relative to underlying productivity … Second, widespread structural barriers make job creation in these [stressed] countries far more arduous than in many other advanced economies.”

Over the decade following the 1999 launch of the euro, the stressed economies of France, Greece, Ireland, Italy, Portugal and Spain collectively raised their productivity by only 7% (substantially less than the 12% productivity growth of the stronger eurozone economies), but boosted nominal wages by 40% (versus only 22% in the healthier economies).  This cost-productivity disadvantage created a substantial competitiveness problem for a number of eurozone countries, with Greece almost in a class by itself. From 1999 to 2008 Greece’s wage growth reached 180%, and public sector wages, which increased by 40% in the eurozone as a whole, rose by 110% in Greece— far greater than productivity gains.  As hiring workers became much more expensive, it was no surprise that fewer workers were hired, causing overall unemployment in Greece to rise to nearly 30%, and to almost 60% among younger workers.

As wage costs in Greece and the weaker eurozone economies rose relative to productivity, countries in Europe with smaller wage/productivity gaps became relatively more competitive.  This shift in competitiveness lead to large trade imbalances, with more competitive economies experiencing trade surpluses and less competitive countries falling into trade deficits.

Overcoming the competitiveness problem requires reducing the wage/productivity disadvantage.  In addition to increasing productivity, another way to attack the problem is to reduce the high labor costs that discourage employers from hiring workers.  As Thimann emphasizes, the focus for labor cost reduction should be on reduced taxation and social insurance charges on businesses, rather than on lowering net compensation for workers.

The second problem holding back job creation, especially in Greece, results from the significant structural barriers to private sector growth, including complexity, cost burden, and uncertainty stemming from regulatory and bureaucratic environments.  In the Global Competi­tiveness Indicators compiled by the World Economic Forum, Greece is 76th out of 148 countries ranked in the world, with virtually no advanced country ranked lower.  If stressed eurozone countries want to overcome their core economic problem of chronically high unemployment, they must reduce their wage/productivity disad­vantage and ease the excessively burdensome business environment.