The labour market has not adjusted to the weaker economic environment

Labour costs increased a little more slowly in the first half of 2014 than they had earlier, but still notably faster than the total value added created in the economy. There are several reasons why the rapid growth in labour costs in companies has not yet stopped. One is that there is no sense in companies reducing their numbers of employees if they expect demand to recover, because then they will need to hire new employees, which is costly. As the euro-area economy continues to grow slowly and several of Estonia’s main trading partners are struggling economically, the ability of companies to raise their profitability given the high labour costs will depend on whether they manage to find export orders from rapidly growing markets or to increase their market share there.

Any reduction in the speed of wage growth is being hampered by labour shortages. This is pushing companies to compete for labour much more than before with both local and foreign employers. The shrinking supply of labour and the ease with which workers can go abroad to find a job have made recruitment ever more difficult. Current employees may thus be retained to hedge against staffing risks, though if this continues for a long time at the expense of profits it will increase the vulnerability of companies.

The first signs appeared in the first half of this year that labour costs may have begun to adjust to the weakness in economic activity that has reigned for a long time. Data from the Labour Force Survey show that employment and hours worked per employee both fell slightly, while wage growth slowed in the second quarter. The adjustment has still been modest in scope though.

The decline in the working age population will affect the labour supply over the long term. The number of people of working age fell last year by 0.9%, mainly because of natural demographic processes like the fall in the number of young people. In the coming years, the small birth cohorts of the 1990s will be finishing their higher education studies and entering the labour market, and their low numbers will further reduce the supply of qualified labour. The small number of people entering the labour market can be offset by investments in human capital. This will require efforts to stop young people dropping out from  professional or higher education schools and to strengthen the connections between schools and the future employers.

The quality of labour is not determined only by the level of education of the young people entering the labour market. Rapidly developing technology means that further education and training for adults is essential for both those with jobs and those without. The share of employees who do further training is much smaller in Estonia than elsewhere in Europe. Only the half of people looking for work have registered as unemployed, which they must do to take training courses through Töötukassa, the unemployment insurance fund. In addition, there are many others who would like to work but are not actively seeking a job. This means there are many ways that potential economic growth could be raised through human capital.

Source: Bank of Estonia

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

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