Competitiveness: Is it time we addressed the elephant in the room?
(Second of two parts)
Unit labour cost (“ULCs”) is a well-known measure of international competitiveness which combines labour cost and productivity into a single measure. In general, unit labour costs show how much output the economy receives relative to wages, or labour cost per unit of output.
ULCs can be estimated by the ratio of labour compensation to real GDP. Factors that relate to changes in ULCs depend on the source from which the change originates. For example, increases in labour costs may result from upward wage pressure, from slow or negative productivity growth or a combination thereof. A productivity slowdown may be the result of a rise in the sector's share of output, lack of technological progress, or slow reform in product or labour markets. In general, countries with rapid productivity growth rates are better positioned to sell their products and services at lower prices. However, competitiveness is not only determined by productivity, but also by all of the costs of inputs in the productivity process.
Often countries with low levels of ULCs relative to other countries are regarded as competitive. However, ULCs should not be interpreted as a comprehensive measure of competitiveness, but as a reflection of cost competitiveness. Unit labour cost measures deal exclusively with the cost of labour. They should also be considered in relation to changes in the cost of capital, especially in advanced economies.
The rise in an economy's unit labour costs could represent an increased reward for labour's contribution. There has been an increasing trend in the real dollar value of ULCs, ranging from $0.38 in 1996 to $0.71 in 2011. In other words, the average cost of labour in 2011 was $0.71 for $1 of real GDP output.
Bermuda's ULCs have grown at a rather rapid annualised pace of 4.2 percent since 1996.
This compares to the G7 countries annualised growth of 1.7 percent.
Up until 2001, Bermuda's ULC growth rate was very similar to other G7 countries. Then something changed. ULCs in Bermuda began to rapidly accelerate at over four percent per annum compared to G7 economies two percent growth. 2005 proved to be the largest jump in ULCs, a surge of 11.1 percent. Since 2010 ULCs have actually begun to deflate, falling five percent in 2011 and another four percent in 2012. The precise explanation for these changes depends on various factors.
It probably will not surprise readers that If we break down the composition of ULCs into the private and public sector we can note that the private sector appears far more productive than the public sector. In 2011, for example, it took the private sector $0.64 to produce every $1 of GDP it generated.
The public sector, however, cost $1.11 for every $1 produced. It's also worth noting that the recent downturn in the economy has led the private sector to lower ULCs while the public sector ULC value continues to increase.
It's worth noting, however, that the main driver of Bermuda's rapid growth in ULCs is actually not due to the public sectors growth in ULC but rather private sector's substantial rise. The private sector's escalating cost growth has actually outstripped that of the public sector and is only now beginning to deflate. Bermuda's private sector ULCs have actually been growing at a 4.5 percent annualised rate since 1996 versus the public sector's 2.9 percent and the G7s 1.7 percent.
Unit labour cost growth over time is not necessarily a negative thing as long as productivity is growing at a faster rate. It could be argued that labour essentially deserves to be paid higher compensation if they produce more per unit of input. For example, I have no problem paying someone $1 million if they produce $5 million in value but I may have a problem paying someone $50,000 if they only produce $49,000 worth of value.
Real pay, or after inflation wages, ultimately depends on productivity. Problems arise, however, when unit labour costs grow faster than productivity. In this case labour compensation gains may not be justified and decreasing levels of competitiveness begin to develop. Growth of ULCs in excess of other nations can at some point lead to reduced competitive ability. For example, the rapid growth in unit labour costs in the southern periphery of Europe has essentially made many of these nations uncompetitive compared to Germany.
In Bermuda, the rise in labour costs is higher than the rise in labour productivity. Therefore, there may be a threat to the economy's cost competitiveness, if other costs are not adjusted to compensate.
Bermuda ULCs annualised growth of 4.2 percent has far outstripped productivity growth of only 1.3 percent since 1996. In fact, over the last ten years we have seen a more extreme divergence with ULCs escalating about 60 percent versus productivity advancing only about three percent.
This rapid cost escalation that is not associated with productivity enhancement, could be pointed too as one potential indicator of Bermuda's failing labour cost competitive position.
A brief sector snapshot offers further details on this divergence. International business (“IB”) labour productivity growth over the past ten years has actually been negative: annualised growth has been -0.8 percent. At the same time ULCs have essentially doubled and grown at seven percent annualised rate. Recently, ULCs have begun to fall in the IB sector, dropping 1.6 percent in 2010 and 6.1 percent in 2011.
This may be a result of outsourcing and downsizing in various IB sub-industries which may be trying to become more cost competitive.
The public administration sector has shown negative labour productivity growth over the past ten years as well. This amounted to a negative 1.1 percent annualised. ULCs have risen about 60 percent over this time period or about 5.0 percent per year.
There has been no reduction in ULCs in the public administration sector over the past ten years.
Productivity will ultimately manifest itself in changes of real pay: wages after inflation. The more workers produce for their employers the more they should earn. If you equip workers with better tools and technology they tend to have the ability to produce more with greater efficiency. Give a gardener a lawnmower and he can cut more grass faster than with a set of clippers. This may, however, not always work. Sometimes these efficiency gains accrue to the employer or, more often, the customer. Take the music industry as an example. You can now buy songs for $0.99 thanks to an efficient and productive delivery system like iTunes while musicians now make the majority of their income touring as opposed to record sales. The consumer benefits with cheaper goods but the producer, in this case, gets a pay cut. Bermuda's wages peaked in 2008 and were stagnant for three years until jumping four percent last year.
If productivity continues to stagnate, it is unlikely we will see future growth in the form of real wages unless the Island allows itself to get increasingly uncompetitive. Productivity growth from 2003 to 2011 was -1.4 percent per annum yet average real wage growth was 2.0 percent. This mirrors the drop in the competitive position of Bermuda as seen above in the growth in ULCs versus the growth in productivity.
Bermuda, from a ULC perspective, appears to be getting less competitive.
This analysis makes it clear that Bermuda needs to seriously focus on productivity growth and the control of unit labour costs or it risks becoming increasingly less competitive in the global marketplace.
The result of this escalation in labour cost relative to productivity has manifested itself in the exodus of jobs from the Island in sectors that are very labour intensive and cost sensitive. An example of this would be the hollowing out of the hedge fund admin sector where wage sensitivity is one important factor in conducting business. Factors that might lead to increases in productivity include technological innovation, capital accumulation, increased skill of workers through improved education and training, increased access to natural resources, changes in labour processes such as division and specialisation, changes in business practices, and changes in patterns of trade.
Unit labour costs and wages need to be watched as they appear to be rapidly outstripping any labour productivity gains. Increasing Bermuda's competitive position will be crucial to attracting foreign capital and investment. It will be a key aspect to factor in to any recovery for the nation.