Labour market review 1/2014

KEY DEVELOPMENTS IN THE SECOND HALF OF 2013 (Source: Bank of Estonia)

The trends in the second half of 2013 were rather contradictory for the Estonian economy. Economic growth was weak, but the weakness came mainly from certain individual industries. In Finland, the most important target destination for Estonian exports, there was negative economic growth that affected a lot of Estonian exporters. Although there was greater confidence in the recovery of the euro area, external demand was weak. The adjustment to an environment of weak demand was also reflected in the labour market, as 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.

Despite the weak economic growth however, wages grew rapidly in Estonia in the second half of 2013. The wage growth was mainly driven by the public sector, but there was no substantial slowdown in the rise in labour costs in companies in the private sector. Labour costs rose throughout the year distinctly faster than productivity. This is permissible in the short term, but not in the long term, unless there are changes in the structure of the economy. A short-term rise in unit labour costs when there is an unforeseen fall in output is quite normal. If demand recovers, then it may be possible to grow out of the imbalance so that productivity grows faster than wages for some time.

Recent political events have unfortunately reduced the likelihood of companies successfully increasing output with support from external demand. This means that the rise in labour costs will soon slow, and the risk that this will happen more sharply than previously forecast has increased. Labour costs can be adjusted through two channels, employment or wages. For the economy as a whole it is better if jobs are preserved, which requires a larger correction in wages.

Wage pressures came from several sources last year. Wages in the public sector started to rise after the crisis a bit later than those in the private sector, and so there was a feeling there that people were being left behind by rising incomes. However, the state should not become the driver of wage growth.

This is partly because it would make wage adjustment in the private sector, which is competing for the same supply of labour, harder, and partly because it would mean the state had more obligations that are difficult to escape, and this could threaten the balance of the state budget. For this reason it is important that public sector wage costs react quickly to adjustments in the labour costs of the private sector. The annual growth in unit labour costs approached 9% in the second half of 2013, implying a serious need for a correction. This growth also touches the three-year maximum growth rate set in the European Commission’s system of indicators that gives warning of imbalances, drawing on the long experience of many countries.

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. The labour supply will be a long-term problem, and the new population forecast by Statistics Estonia suggests that it could be even worse than previously predicted. If the rate of participation in the labour force remains unchanged, then it can be expected that by 2040 the labour force will shrink by one fifth. This will make it even more important for the social security system to be designed to encourage people to participate in the labour market, so that social benefits are not reduced 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.

Behind the shortage of labour and any reduction in it stands the high structural unemployment in Estonia. Reducing structural unemployment and raising the competitiveness of the long-term unemployed in the labour market will ease social problems, and it will also provide a way of increasing employment despite the unfavourable demographic situation. The risk of unemployment has so far been notably above average for young people and residents of Ida-Virumaa and is increased by low levels of education and by a lack of Estonian language skills. Statistics also show that unemployment is higher among non-Estonians. Although the budget for active labour market measures for each unemployed person has increased in recent years, the spending on such measures is generally still low in international comparison. The obstacles for risk groups in the labour market are often related to problems whose solutions will require not only active labour market measures, but also support from regional, education and population policies.

Read more from Bank of Estonia website

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