Unit labor costs in the eurozone: the competitiveness debate again

Unit labor costs in some of the eurozone countries, calculated using aggregate data, increased significantly during the years before the crisis. In this paper, we show that: (i) the construction of unit labor costs using aggregate data, the standard practice, leads to serious problems of interpretation; (ii) aggregate unit labor costs are not a sum or an average of firms’ unit labor costs; and (iii) aggregate unit labor costs are simply the product of the share of labor in total income times the aggregate price deflator. As such, they simply reflect the distribution of income between wages and profits. We conclude that aggregate unit labor costs should not be calculated, and certainly should not be used as a measure of competitiveness. Data for 1980–2007 confirms that aggregate unit labor costs increased across the eurozone. But of the 12 countries studied, the labor share declined in nine, it increased in one (Greece), and it remained constant in two. Overall, aggregate unit labor costs increased as a result of the increase in the price deflator. We conjecture that the increase in unit labor costs was the result of the non-tradable sectors gaining share in the overall economy. Recent data for 2008–2012 indicate that aggregate unit labor costs have stopped increasing and have even declined in some countries. This is due to the fact the labor shares have continued declining and that the overall price deflator has dramatically reversed its upward trend, either flattening or declining.