Slow economic growth has a visible impact in the labour market

In the second half of 2013 the first signs of slower economic growth having an impact in the labour market appeared. Employment in the second half of the year was at about the level of a year earlier and unemployment rose at the end of the year, but the decline in the working age population meant that the employment rate actually increased.

Despite the weak economic growth, wages grew rapidly in Estonia in the second half of 2013 and distinctly faster than productivity. Recent developments have reduced the likelihood of companies successfully increasing profitability with support from external demand. In consequence, a slowdown in the growth of labour costs can be expected soon and it is more likely to be sharper than was previously thought.

Wage growth accelerated in the second half of the year in the public sector, where wages started to rise after the crisis a bit later than those in the private sector. However, the state should not become the driver of wage growth. This is partly because it would make wage growth adjustment in the private sector, which is competing for the same supply of labour, harder, and partly because rapidly rising labour costs would make it harder for budget goals to be met. This risk is even greater when there is a lot of uncertainty about economic growth and fiscal revenues.

The second main source of wage pressures was again the shortage of qualified labour and the strengthening of the position of employees in wage negotiations, which is backed in some cases by the option of going to work abroad. Behind the shortage of labour and any reduction in it stands the high structural unemployment in Estonia. Although the budget for active labour market measures per unemployed person has increased in recent years, the spending on such measures is generally still low in international comparison. The participation of risk groups in the labour market is often hindered by problems that cannot be solved only through active labour market measures but need support from regional, educational and population policies.

If the rate of participation in the labour force remains unchanged, then the labour force will shrink by one fifth by 2040. The new population forecast from Statistics Estonia expects the reduced supply of labour could last for a long time and could be even more serious than was earlier forecast. This will make it even more important for the social security system to be designed to encourage people to participate in the labour market, and it should not reduce social support by the same amount that an additional earned income brings in to the family budget. This principle should be used for reassessing those benefits where not working is a condition for receiving the benefit, such as an early retirement pension, or where the marginal tax rates are very high, as with income support.

Source: Bank of Estonia

Authors:  Orsolya Soosaar and Natalja Viilmann, Economists at Eesti Pank

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