U NIT LABOUR COSTS AND COMPETITIVENESS

In 2003 Q1, the growth rate of unit labour costs with-in the private sector contwith-inued to declwith-ine as expect-ed. This was because while labour costs rose at the previous rate, productivity improved substantially, especially in manufacturing.

The Bank expects the growth rate of unit labour costs to decline gradually in the future, due to slower wage inflation and higher productivity. The projection for unit labour cost growth in the private sector is 5.1% in 2003 and 3.9% in 2004. As the inflation projection for the forthcoming period exceeds the current projection, the labour side profitability of companies is expected to improve at a steady pace both in 2003 and 2004.²³ As a result of the weakening of the nominal exchange rate in June, the manufacturing real exchange rate depreciated as a one-off but substantial change. With the technical assumption that the July exchange rate of the forint remains stable, manufacturing compa-nies’ competitiveness based on unit labour costs will improve by approximately 7% in 2003, in terms of a one-off change, and remain unchanged in 2004.

Because of the acceleration of inflation, price-based competitiveness only improves by 2% this year and deteriorates by roughly 5% in 2004.

In recent years, growth in real wages has substantially exceeded productivity growth both in manufacturing and market services. As a consequence, firms’ labour-side competitiveness has been on a steady decline ever since early 2001, which prompted the Bank to project increased corporate efforts to make adjust-ments in the labour market. The reference period, however, witnessed only a slow labour market adjust-ment, implemented by the theoretically more costly reduction in employment rather than by curbing wage inflation.

The need to adjust varied in size across the sectors. Due to the direct impact of developments in external demand, manufacturing companies were forced to make stronger adjustments than firms engaged in the

area of market services, supported by robust domestic demand. As manufacturing companies responded quickly to the reduced production by cutting employ-ment, there was no decline in their productivity during the crisis. Indeed, they have been able to report annual productivity growth of 2.5% every year since early 2002. However, nominal wages were first brought in line with disinflation as late as the second half of 2002, when there was a major slowdown in the growth of real wages in manufacturing, dropping nearly to the rate of productivity growth. Even though the adjustment of nominal wages came to a halt in 2003 Q1 (see Section on Wages), firms’ labour-side profitability stopped dete-riorating as rapidly as before, thanks to a further pick-up in manufacturing productivity.

3.4 U NIT LABOUR COSTS AND COMPETITIVENESS

Productivity, wages and profits in manufacturing*

(Annualised quarter-on-quarter growth rates)

Chart 3-9

1997 Q4 1998 Q4 1999 Q4 2000 Q4 2001 Q4 2002 Q4

1997 Q2 1998 Q2 1999 Q2 2000 Q2 2001 Q2 2002 Q2 2003 Q2

Per cent

* Changes in profits are approximated using the inverse of real ULCs (see May Report). In fact, the category included in the chart denotes a term whose meaning is narrower than that of the rate of profit, for it does not comprise cost elements other than labour. Data on the actual developments of the first three months of 2003 are only avail-able for two months. Data on the remaining one month have been estimated using statistical methods.

Due to the effect of the June 2003 shift in the exchange rate band and the June depreciation of the forint, there was significant one-off, temporary depreciation in the ULC-based real exchange rate in manufacturing in 2003 Q2. (Assuming that the nominal exchange rate ruling in July remains stable, the ULC-based real exchange rate will depreciate by approximately 7% this year.)

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3 LABOUR MARKET AND COMPETITIVENESS

3

Output growth in the area of market services has been balanced over the past few years, thanks to robust domestic demand. Indeed, this sector managed to record similar growth in productivity to manufacturing, despite a steady rise in numbers employed. As increas-es in the minimum wage impeded the adjustment of nominal wages to disinflation, profitability in market services was not able to improve considerably in the ref-erence period, despite buoyant activity.

The Bank expects the growth rate of domestic unit labour costs to decline steadily in the future. This will be partly due to faster growth in productivity and partly to declin-ing wage inflation. Improvement in manufacturdeclin-ing pro-ductivity may be fostered by stronger economic activity, while the Bank expects market services employment to grow at a considerably slower pace. Hence, the Bank’s projection for private sector productivity growth is 3.2%

in 2003 and 3.8% in 2004. The Bank also expects wage inflation to lose momentum over the forecast horizon (see Section on Wages), leading to a drop in unit labour cost growth to 3.9% in 2004.

Productivity, wages and profits in market services*

(Annualised quarter-on-quarter growth rates)

Chart 3-10

1997 Q4 1998 Q4 1999 Q4 2000 Q4 2001 Q4 2002 Q4

1997 Q2 1998 Q2 1999 Q2 2000 Q2 2001 Q2 2002 Q2 2003 Q2

Per cent

* Changes in profits are approximated using the inverse of real ULCs (see May Report). In fact, the category included in the chart denotes a term whose meaning is narrower than that of the rate of profit, for it does not comprise cost elements other than labour. Data on the actual developments of the first three months of 2003 are only avail-able for two months. Data on the remaining one month have been estimated using statistical methods.

Productivity, wages and unit labour costs in the private sector

(Annualised quarter-on-quarter growth rates)

Chart 3-11

1997 Q2 1998 Q1 1999 Q3 2000 Q2 2001 Q1 2002 Q3 2003 Q2 2004 Q11998 Q4 2001 Q4 2004 Q4

Per cent

ULC-based real exchange rate, manufacturing*

1995 Q1 1996 Q3 1997 Q2 1998 Q1 1999 Q3 2000 Q2 2001 Q1 2002 Q3 2003 Q2 2004 Q11995 Q4 1998 Q4 2001 Q4 2004 Q4

1995 = 100

Actual Forecast May Forecast

* Higher values denote real depreciation.

QUARTERLY REPORT ON INFLATION

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3 LABOUR MARKET AND COMPETITIVENESS

3

Price-based real effective exchange rate indicators*

Chart 3-13

65 70 75 80 85 90 95 1995 = 100100

65 70 75 80 85 90 95

1001995 = 100

Manufacturing producer prices Consumer prices

2004 Q1

1998 Q3 1999 Q3 2000 Q3 2001 Q3 2002 Q3 2004 Q3

1998 Q1 1999 Q1 2000 Q1 2001 Q1 2002 Q1 2003 Q1

* Higher values denote real depreciation.

Expecting Hungarian unit labour costs to increase at the same pace as those abroad, the Bank uses a constant assumption for the real exchange rate in 2004.

The picture is less rosy with regard to price-based com-petitiveness, due to direct inflationary pressure, with a projected improvement of roughly 2% in 2003 and 5%

deterioration in 2004. Thus, the projection is based on the assumption that the shift in the exchange rate band will only improve domestic competitiveness in the short term and to a limited extent.