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Policy Contribution

Compositional effects on productivity, labour cost and export adjustments

Sectoral shifts, such as shrinkage of low labour productivity and the low-wage construction sector, can lead to apparent increased aggregate average labour productivity and average wages, especially when capital intensity differs across sectors. This policy contribution concludes that: 1)The compositional effects are significant in a number of countries. 2)The real exchange rate well correlates with export performance. 3)Among the EU countries facing the most severe external adjustment challenges, Lithuania, Portugal and Ireland have been the most successful based on five indicators, yet Spain is the best performer in the EU15 in terms or export growth. 4)There is some evidence of downward wage flexibility, but this did not prove to be sufficient for avoiding massive employment losses.

By: Date: June 22, 2012 Topic: European Macroeconomics & Governance

Sectoral shifts, such as shrinkage of low labour productivity and the low-wage construction sector, can lead to apparent increased aggregate average labour productivity and average wages, especially when capital intensity differs across sectors.

For 11 main sectors and 13 manufacturing sub-sectors, we quantify the compositional effects on productivity, wages and unit labour costs (ULCs) based and real effective exchange rates (REER), for 24 EU countries.

Compositional effects are greatest in Ireland, where the pharmaceutical sector drives the growth of output and productivity, but other sectors have suffered greatly and have not yet recovered.

Our new ULC-REER measurements, which are free from compositional effects, correlate well with export performance.

Among the countries facing the most severe external adjustment challenges, Lithuania, Portugal and Ireland have been the most successful based on five indicators, and Latvia, Estonia and Greece the least successful.

There is evidence of downward wage flexibility in some countries, but wage cuts have corrected just a small fraction of pre-crisis wage rises and came with massive reductions in employment even in the business sector excluding construction and real estate, highlighting the difficulty of adjusting wages downward.

As a background document for this Policy Contribution, Zsolt released the working paper Productivity, labour cost and export adjustment: Detailed results for 24 EU countries which presents detailed results for 24 EU countries on: sectoral changes in the economy;Unit labour costs (ULC) based real effective exchange rate (REER) and its main components; Export performance.

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