Boundaries

• Taking the data at face value,  we find that GDP growth in the 4 quarters up to 2Q2012 has slowed down to 1.2%, while employment growth during the same period reached 1.9%, developments that suggest productivity coming down by 0.7%;

• That said, there are indications that labor productivity is procyclical, i.e., it tends to rise when the economy recovers and contracts as growth slows down. In light of this, we attempt to estimate how fast productivity should grow once the economy accelerates back, following the massive fiscal, monetary and credit impulses in place;

• Our estimates suggest that productivity growth can indeed reach above trend next year, around 2%, compared with trend growth close to 1.5% per annum;

• Yet, even with additional productivity growth we conclude that it is not possible to expand more than 3-3.5% next year without further tightening of the labor market. Indeed, growth in excess of these levels would require further increase in labor force participation, a variable whose trend – despite demographic transition – has remained remarkably constant during the past years.

• It is conceivable, however, that labor force participation deviates from the trend, as it has done quite a few times in recent years, at least for a while. If it reaches the maximum levels observed since the beginning of the series it can sustain growth in the vicinity of 4%;

• However, in order to lure workers into the labor force, wages would have to increase even faster than current observations (around 9-10% compared with the same period last year). These levels would still surpass, by a large margin, productivity growth, despite its procyclical nature;

• Hence, the ensuing increase in unit labor costs would translate into additional inflationary pressures for non-tradable goods, maintaining inflation still above target;

• As for the tradable sector, notably manufactures, rising unit labor costs would erode competitiveness, prompting renewed calls for protection and further currency depreciation, which local authorities are likely to oblige. I would not be surprised, thus, should authorities gradually move the exchange rate band from current levels in order to offset the impact of rising labor costs.

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