International Comparisons of Labor Costs in Manufacturing

International Finance Discussion Papers Number 330

August 1988

INTERNATIONAL COMPARISONS OF LABOR COSTS IN MANUFACTURING

Peter Hooper and Kathryn A. Larin

NOTE: International Finance Discussion Papers are preliminary materials circulated to stimulate discussion and critical comment. References in publications to International Finance Discussion Papers (other than an acknow..edgment that the writer has had access to unpublished material) should be cleared with the author or authors.

ABSTRACT

This paper presents a comparative study of the level of unit labor costs in the manufacturing sectors of several countries. The paper begins by surveying earlier estimates of relative productivity and unit labor cost levels and evaluating the various methodologies that have been used in previous studies. Empirical estimates of the levels of foreign unit labor costs in dollars are derived based on labor compensation translated into dollars at nominal exchange rates and labor productivity translated into dollars at purchasing power parity exchange rates. These estimates are compared with results obtained in earlier studies. The results show that the level of unit labor costs in the United States has fluctuated significantly in recent years, predominantly with fluctuations in the nominal exchange rate. As of early 1988, unit labor costs in the United States had dropped well below the average level of other industrialized countries but were significantly

above the level in a representative newly industrialized country, Korea.

International Comparisons of Labor Costs in Manufacturing Peter Hooper and Kathryn A. Larin! I. Introduction and Summary

Large swings in nominal exchange rates since the early 1970s have resulted in substantial shifts in the international competitiveness of manufacturing sectors across countries. These shifts in competitiveness have had major impacts on the performance of domestic manufacturing sectors in various countries. The slowing of the growth rate of the U.S. manufacturing sector during the first half of the 1980s, for example, has been attributed in part to the loss in competitiveness associated with the sharp appreciation of the dollar during that period. Given the sensitivity of manufacturing to such international influences, considerable effort has been put into developing empirical indicators of competitiveness.

An important indicator of competitiveness is the relative level of labor costs in manufacturing, since labor represents the most important non-traded input into manufacturing. The purpose of this paper is to survey attempts that have been made to measure the relative levels of labor costs in manufacturing and to compute an up-to-date set of empirical estimates, primarily for major industrial countries. Section II defines what we mean by comparative labor costs, and presents a survey of previous studies and the various methodologies that have been

employed. Section III describes our own methodology and data, and

1. The authors are members of the staff of the Board of Governors of the Federel Reserve System. The views expressed here are our own and do not necessarily reflect the views of the Federal Reserve Board or other members of its staff. We have benefitted from conversations with Steven N. Breun and Arthur Neef, as well as from comments on an earlier draft by David H. Howard, Linda Kole, Jaime R. Marquez and Ralph Tryon.

Section IV presents our empirical estimates. We find that as of early 1988, U.S. unit labor costs were probably significantly lower than those in Europe and Japan, but still well above those in a representative newly industrialized country (Korea). However, this result should be interpreted with caution as we also find that estimates of relative levels of unit labor costs lie in a fairly wide range, depending upon the

methodology that is used to calculate them.

Il. Definitions and Literature Survey

The simplest measure of comparative labor costs, and one which receives much attention in the popular press ,* is based on wage rates or total compensation. However, differences in compensation often reflect differences in labor productivity across countries. Countries with high productivity tend to have high labor compensation, ceteris paribus, Most studies of comparative labor costs therefore focus on unit labor costs (ULC), defined as total compensation (C) per hour employed (H), divided by productivity, or total output (0) per hour:

(1) ULC = (C/H)/(0/H) where C is measured in nominal currency units and O is measured in real terms (at prices in some base period). In principle, the productivity component (O/H) can be purged of cyclical influences by using a measure of trend productivity, to yield "normal" unit labor costs. This generally has not been done in the literature on international

comparisons, partly because the focus on longer term trends in relative

2. See, for example,"International Comparison of Labour Costs and

Output," Dresdner Bank Economic Quarterly, vol. 95 (November 1987), pp.

3-7; “American Industry is Back in Fighting Trim," Business Week, March 7, 1988; "U.S. Wages Slip to Third Place," Nation's Business, December

1986.

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labor costs tends to diminish the importance of cyclical fluctuations in productivity.

The central problem concerning intercountry comparisons of labor costs is how to translate the costs calculated for individual countries into comparable or common-currency units. The most straightforward method is to multiply each country i's local-currency unit labor cost (ULC; ) by its current nominal exchange rate against the numeiaire currency (generally the dollar):

(2) ULC? - ER; xX ULC; where ER; is the $/i-currency exchange rate. This methodology implicitly involves translating the compensation component of ULC into current dollars (at the current nominal exchange rate), while leaving the output (or productivity) component valued in terms of base-period prices in the local. currency:

(3) uLc? = (ER,x C;/H,)/(O,/H,) The IMF regularly publishes indexes of unit labor costs for a number of countries (in each case expressed relative to an average of indexes for the whole group of countries), based on this methodology .> These indexes provide a good indication of movements in relative unit labor costs over time, but they cannot be used (as they sometimes are, mistakenly) as indicators of the relative levels of unit labor costs at any point in time.” This is because whereas the compensation component

of ULC in (3) has been translated into dollars, the output (or

productivity) component is still measured in terms of foreign currency.

3. See IMF International Financia] Statistics, "Cost and Price

Comparisons in Manufacturing." 4. See, for example, Jasinowski, Jerry J., "The Low Dollar Has Worked Wenders," The New York Times, April 10, 1988.

A meaningful comparison of levels requires translating O as well. as C into dollars.

Translating foreign real outputs into dollars at market: exchange rates can be quite misleading. This is because, as shown by Isard (1977) and others, it is not unusual for the prices of a particular gocd to differ substantially across countries when translated into common currency units at market exchange rates. To take an example, if a) total output of a particular type of machinery in Germany is valued at DM3 million (at 1980 prices), b) total output of the same type of machinery in the United States is valued at $1 million (at 1980 prices), and c) the market exchange rate in 1980 was DM/$ = 3.0, translation of the German output at the market exchange rate would indicate that U.S. and German real outputs were the same in magnitude (both equal to $1 million). However, it is quite possible that German prices in the same base year, when translated into dollars, differ significantly from U.S. base-year prices. If, for example, the U.S. base-year price of a unit of the machinery in question was $100, and the German price was DM150, or half the U.S. price in dollars (at DM150/3.0 = $50), the comparison of outputs using market exchange rates would understate the quantity of German physical output (i.e. the number of machines produced) relative to U.S. output by a factor of two.

In the past three decades a considerable literature has been devoted to getting around this valuation problem in the international comparison of real outputs, by developing purchasing power parity exchange rates to translate outputs into common currency units. A purchasing power parity (PPP) exchange rate is the ratio of the local

currency prices of a particular basket of goods in two different

countries -- for example, the number of marks it takes to buy a basket of goods in Germany relative to the number of dollars it takes to buy the same basket of goods in the United States. In terms of the example given above, the purchasing power parity exchange rate for the machinery in the base year (1980) would be equal to DM150/$100 = 1.5. The dollar value of German output of machinery translated at this PPP rate would be DM3 million/1.5 = $2 million (at 1980 prices), or double quantity implied by the use of the current market exchange rate.

With the use of PPP exchange rates to translate outputs into common currency, foreign unit labor costs in dollars are computed as:

(4) uLc? - (ER;x C, /H,)/(PPP;x 0,/H;) where PPP, is country i’s PPP exchange rate for manufactured goods vis-avis the dollar. Thus, the foreign country’s labor compensation per hour is translated into dollars at the current market exchange rate, while its productivity (measured at constant base year prices) is translated at the base year IPP exchange rate.

Two different approaches have been used to compute PPPs specific to manufacturing output. One approach, (the "industry approach") is to collect data on output and prices at the industry level. Paige and Brombach (1959) compared United Kingdom and United States output and productivity in the 1950’s by constructing PPPs using census data on net outputs and prices for a large number of narrowly defined individual industries. Their efforts were repeated and updated by Smith, Hitchens, and Davies (1982) for the years 1968-1977 in another study that focused

on highly disaggregated industry comparisons between the United States,

5. For a more complete discussion of the theory of PPP exchange rates for intercountry comparisons, see Hill(1982,1986), and Kravis, Heston, and Summers(1982).

the United Kingdom, and Germany. By using output data at the incustry level, Smith, et al. were able to pinpoint the specific contributions of different sectors to each country’s comparative advantage. Data for this type of comparison are not readily available for most countries, however, and are costly to compile in countries for which they are available. Industry output studies have consequently been limited to the comparison of very few countries.

Another approach to calculating PPP exchange rates (the "expenditure approach") uses data on the comparative levels of prices of disaggregated final expenditures rather than prices of disaggregated industry outputs. For several reasons, the expenditure approach is less desirable than the industry approach. First, the prices of final expenditures include indirect taxes and subsidies, which may differ significantly across countries. Additionally, expenditures on imported goods cannot be readily separated from expenditures on domestically produced goods. Nevertheless, the expenditure approach has an advantage in that intermediate goods are netted out, thereby avoiding the double counting inherent in the industry approach. More importantly, detailed breakdowns of PPPs by expenditure category have been made available recently for a large number of countries by the U.N. International Comparisons Project (ICP).

The ICP was established during the late 1960's as a cocperative effort on the part of many countries and agencies to estimate a consistent set of PPP exchange rates to aid in cross-country comparisons of GNPs (see Kravis, Kenessey, Heston, and Summers (1975); Kravis, Heston and Summers (1978,1982); United Nations (1987)). By 1985, these PPP

calculations had been expanded to include 60 industrial and developing

countries. The PPPs published by the ICP were broken down by expenditure categcory and a PPP rate for total GNP was calculated as the weighted average of the PPPs for each individual expenditure category.° The availability of these aggregate PPP rates enabled a number of studies to consicer international comparisons of total GNP productivity for a wide range of countries (See Bergson (1977); Christenson, Cummings and Jorger.son (1981); Kravis (1976))

International comparisons at the industry level, or for the manufacturing sector as a whole, have been more limited in scope and number. Prais (1972) used expenditure breakdowns provided by the ICP study to construct bilateral PPP rates for the manufacturing sector alone, and used them to compare census data on output for the United States, the United Kingdom, and Germany. Roy (1982) followed a similar approach to examine relative productivity levels in various industries and tctal manufacturing in the United States, the United Kingdon, Germany, Italy, France, Belgium, Japan, and the Netherlands. Roy compared his results, based on 1975 PPPs, to the earlier industry studies to determine the sensitivity of productivity estimates to the type of PPP used. He found significant differences at the individual industry level between his estimates based on the expenditure approach and earlier estimates based on the industry approach. However, he also found that for the manufacturing sector as a whole, the results obtained by the two approaches were generally quite similar.

In a more recent study of the levels of relative production

costs in manufacturing, Gault (1985) calculated bilateral PPP exchange

6. The weights used for each expenditure category in these calculations were essentially averages of the total values of expenditure on that category in the two countries for whom the PPP rate was being calculated.

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rates for manufacturing for 1975 using expenditure-based data as in Prais and Roy. Gault refined his measure of productivity by taking into account hours worked as well as total employment.

Two additional studies have been conducted more recently using similar methodologies. The OECD (1987) used essentially the same methodology as Gault to obtain relative labor productivities, using PPPs for the year 1984 that are consistent with the ICP data. Hickok, Bell, and Ceglowski (1988) used this methodology to compute relative unit labor costs in manufacturing for Japan, Germany, and the Untied States, based

on ICP PPPs for 1975.

III. Methodology and Data

Our computation of comparative unit labor costs is basecl on equation (4) above. Foreign compensation per hour is translated into dollars at current market exchange rates and foreign productivity at base year (1980) PPP exchange rates. We use the expenditure approach to calculate PPP exchange rates for manufacturing, similar to the methodology used by.Gault and other recent studies described in the preceding section. The rest of this section describes the specific data we employ. A. Compensation Data

The most comprehensive standardized cross-country data on relative levels of compensation in manufacturing are compiled by the U.S. Bureau of Labor Statistics (BLS). Compensation (for production workers) is defined as payments made to the worker plus benefits such as social insurance contributions, bonuses, private benefit plans, vacation, and

sick leave. The only benefits excluded from the BLS figures are

facilities such as cafeterias and medical units, and recruiting costs, which are difficult to measure, and are estimated to account for less than 4 percent of total compensation. The levels of compensation are converted to U.S. dollars by the BLS at current market exchange rates and yield level comparisons that are comparable across countries. The data (shown in Table 1) are available through 1987 and have been extrapolated to 198& using actual exchange rates for the first half of 1988 and assuming that compensation per hour in local currency would continue to grow through 1988 at the average annual rate observed for 1980-1987. B. Productivity Data

Output per hour in real terms in national currency units is calculated by dividing total manufacturing output by the total number of hours worked by all manufacturing employees (total manufacturing employment times the average number of hours worked per employee). The data for each of these elements are also maintained by the BLS. The BLS collects its data from the national accounts of each of the inclividual countries; an effort is made to standardize the data across countries. Output levels are defined as gross domestic product in manufacturing, measured at market prices where possible. Employment data, which are consistent with compensation data, are also standardized across countries to the degree possible. Where more than one manufacturing employment survey per country is available, an average of the available sources is used.

We have used BLS data for all of the industrial countries included in our analysis. The only adjustment to these data was to the

U.S. figures for hours worked. Because the U.S. measure represents hours

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paid rather than hours worked, the data are adjusted, based on a BLS survey showing that hours worked had held fairly steady at 91 percent of hours paid over the period 1975 to 1985.’

The BLS does not maintain data on employment and hours worked for Korea. Employment information is therefore taken from the Bank of Korea, Monthly Statistical Bulletin, while data on hours worked are provided by the International Labour Office. The output, employment, and hours worked data used in calculating the 1980 base year estimates of output per hour for each of the countries in our analysis are shown in Table 2.

C. PPP Data.

To convert output levels to common currency units, PPP exchange rates specific to manufacturing are constructed, based on data obtained from Phase IV of the United Nations International Comparisons Project, Worli Comparisons of Purchasing Power and Real Product for 1980. Total GDP PPPs are broken down by expenditure category into approximately 48 commodity groups. Data are also provided for per capita expenditures on each commodity group by the residents of each country.

The expenditure categories selected to represent the manufacturing sector are shown in Table 3. The total bilateral PPP exchange rate for each country (units of local currency per U.S. dollar) is calculated as a geometric weighted average of the individual commodity PPPs (shown in the top panel of Table 3), as follows:

PPP, = 4 PPP, , 13

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where PPP, is country i’s weighted average bilateral dollar PPP exchange

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rate, Wij is the expenditure share weight specific to each of the & commodity categories j, for each country i, ant PPP, is country i’s PPP exchange rate for category j. The weight Wij is the geometric mean of own-country (i) expenditure share for commodity category j (E55) and the

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bottom panel of Table 3,89 Using the productivity estimates calculated in national currencies and the PPP exchange rates, productivity estimates in dollars

were calculated for each country in the base year (1980). The BLS indexes of output per hour in manufacturing were then used to exterid the series backward and forward in time. Indexes were available through 1987 for the industrial countries. The 1988 values were estimated by

extrapolating average productivity growth rates over the period 19&0 to

1987; the results are shown in Table 4. The Korean index was created

8. The expenditure weights for food, beverages, and tobacco in Table 3 were reduced by 20% below those reported by the ICP based on the 1977 input-output tables, which indicated that only 80% of total food, beverage, and tobacco expenditures represented expenditures on manufacturing output. The fuel weight was reduced by 67%, as most fuel expenditures constitute expenditures on non-manufacturing output.

9. There has been some debate in the literature over the use of bilateral expenditure weighting as opposed to multilateral weightirg, especially when comparing several countries. The multilateral approach uses identical weights for each country, based on the average expenditures of all countries on each commodity category. Gault used both the bilateral and multilateral approaches in his study, and found that the results for European countries were not changed significartly by the use of a multilaterally weighted PPP rate, However, the multilateral approach led to slightly higher productivity estimates for Japan ard Korea.

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using data from the Bank of Korea.

As indicated in Table 4, the United States has maintained a significant productivity advantage over most industrialized countries since 1960. Belgium, the Netherlands, and Canada also have had relatively high levels of output per hour in the 1970s and 80s, a result that has been corroborated by earlier studies of both manufacturing and total GDP productivity (Roy (1982), Christensen, Cummings, and Jorgenson (1981), Kravis (1978)). The unexpectedly high productivity estimates for Italy are largely because of an unusually low PPP exchange rate for foods, beverages, and tobacco, combined with an unusually high weight for that expenditure category. While Italy's manufacturing productivity growth rate has been higher than that of most countries studied for the past 15 years, it is possible that the data overstates productivity in this case. The PPP exchange rates employed are necessarily aggregative, and may fail to capture significant differences in the composition of goods within expenditure categories across-countries. Other possible sources of bias include indirect taxes and subsidies and the inclusion of

imports, as discussed ‘earlier. 1°

IV. Results: Comparative Unit Labor Costs in Dollars. Unit labor costs in manufacturing for the ten countries in this

study were calculated by dividing compensation per hour by output per

hour in U.S. dollars. It is evident from the results shown in Table 5

10. Italy's relatively low PPP for food could be explained, for example, by relatively low sales taxes or high subsidies on food expenditures, but we have no evidence that food taxes and subsidies in Italy differ significantly from those in other EC countries.

-17-

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- 18 -

that the cost advantage once held by foreign industrial countries over the United States has been diminishing in recent years, most notably in the case of Japan, but also in France, Italy, Belgium, the Netherlands, and to a lesser extent, in the United Kingdom and Canada. While Germany held a significant cost advantage over the United States in the 1960's and again in the early 1980’s when the dollar was at its peak, it has recently returned to its position as the country with the highest average labor costs in manufacturing. Korea, on the other hand, has easily maintained a significant cost advantage over all industrial countries during the entire period.

Trends in the components of U.S. and foreign unit labor costs can be seen more clearly in Chart 1, which shows productivity, compensation, and unit labor costs for the United States, for a GNP weighted average of eight other industrial countries, and for a weighted average of the two largest foreign producers, Japan and Germany. The top panel shows U.S. and foreign levels of output per hour measured in 1980 dollars. The United States has consistently maintained a higher level of productivity than other industrial countries over the past several decades, although the gap narrowed continuously until about 1980. Compensation per hour in the United States has also remained above that abroad, until quite recently, but the relative movements have been much more variable over time than in the case of productivity. With the exception of a period in the early 1980's when the dollar was appreciating sharply against the currencies of major industrial countries, hourly compensation in foreign countries has been increasing at a faster pace than in the United States. This has been especially

true in recent years, as the depreciation of the dollar led to rapid

-19-

Chart 1

U.S. and Foreign Unit Labor Costs and Their Components

Output per Hour tput pe! 1980 U.S. dollars 25 ———-—— United States ———-— 8 Foreign Industrial Countries

wenn ne Japan and Germany *

15

10

==" = “<7 Seo

Compensation per Hour P P U.S. dollars 18 ———-— United States ——-— 8 Foreign industrial Countries 15 maceee Japan and Germany

12 9 6 3 0 Unit Labor Costs* 120 — United States ———-— 8 Foreign industrial Countries caress Japan and Germany y 90 60 30 ie) 1960 1964 1968 1972 1976 1980 1984 1988

* Compensation per hour divided by output per hour.

increases in foreign compensation levels measured in U.S. dollars, to the point where average foreign compensation exceeded U.S. compensztion levels for the first time in 1987.

The bottom panel of Chart 1 shows the levels of unit labor costs in the United States and in foreign industrial countries. Until the early 1970s, U.S. unit labor costs were above those in other irdustrial countries. During the next several years, as foreign compensat:ion growth accelerated, foreign unit labor costs exceeded those in the United States. The high dollar in the early 1980s helped to reverse the relative levels, but recent estimates indicate that foreign unit labor costs are now significantly higher than U.S. costs.

Chart 2, shows movements in the ratios of foreign to U.S. productivity and U.S. to foreign compensation and unit labor costs, ona ratio scale. The narrowing of the foreign-U.S. productivity differential over much of the period shown has worked to increase the ratio of U.S. costs relative to foreign costs. This effect has been outweighed, however, by changes in compensation per hour in foreign countries relative to the United States. The chart demonstrates clearly the dominant influence that movements in relative compensation levels have had in determining movements in relative unit labor costs, part:icularly during the 1970s and 80s. The growth in foreign relative to U.S. output per hour has been much smoother, and during the 1980s has had very little impact on relative labor costs. Chart 3 shows movements in the ratio of U.S. to foreign unit labor costs and movements in a weighted average of nominal exchange rates over the same period. It is clear that at least

since the early 1970's, relative unit labor costs have been dominated by

-21- Chart 2

Ratios of U.S. to Foreign Unit Labor Costs and Components

Ratio scale ~~ 45 “ \ aN . 3.8 N N \ ‘ ~ se _ 3.1 ~ \ ‘N \ Ratio of US to Foreign Compensation N 2.4 \ \ \ \ \ \ \ 1.7 Ratio of U.S. to Foreign Unit Labor Costs \ / \ ‘ N , - 7 \ N N cr V7 ON / \ \ / \ \ / \ \ / \ ~~ /S \ \ \ \

emnwe”

a ° Ratio of Foreign to US Output per Hour

0.3 1960 1964 1968 1972 1976 1980 1984 1988

-22- Chart 3

Relative Unit Labor Costs and Their Components

i itl h inal h Relative Unit Labor Costs and the Nominal Exchange Rate Index, 1973=100

180

Ratio of U.S. to Foreign*

Unit Labor Costs 160

140

120

100

1960 1964 1968 1972 1976 1980 1984

* Foreign includes Japan, Germany, France, Canada, the United Kingdom, Italy, the Netherlands, and Belgium. ** Weighted by shares in world GNP. .

- 23 -

movements in the nominal exchange rate, 1+

Before drawing any firm conclusions from the estimates of relative unit labor costs presented here, it is important to assess the sensitivity of the estimates to alternative assumptions. One approach is to compare the estimates with those calculated under different assumptions in other recent studies, as described earlier. Table 6 shows measures of foreign productivity expressed as a proportion of U.S. productivity that were calculated in several different studies for Japan, Germany, the United Kingdom, France, and Italy. The industry level study by Smith et al. yielded slightly higher productivity estimates for Germany and somewhat lower estimates for the United Kingdom than the other (expenditure based) studies. These differences could be attributed to the measurement of output and of PPP exchange rates at a detailed industry level rather than at a more aggregated expenditure level. Variations among the other studies are due largely to differences in the particular specification of expenditure categories to represent manufacturing, the use of different base year PPPs, and perhaps minor differences in the data used for total manufacturing output, employment, and hours worked. Overall, however, the estimates fall within a range that is narrow enough to support the conclusions implied by our own estimates. Unit labor costs for each study in the base year, 1980, are presented in Table 7. BLS data on compensation per hour was used to calculate unit labor costs for studies in which only productivity was estimated. Our own estimates (H-L) generally fall within the ranges of

estimates shown.

11. In a simple linear regression, movements in the exchange rate "explain" more than 90 percent of movements in the unit labor cost ratio over the entire period shown in Chart 3.

-24-

Table 6

Alternative Estimates of Labor Productivity in Manufacturing

(Output per hour in dollars, Indexed to U.S. output per hour

Japan 1970 OECD .45 Gault .43 Roy NA H-L 44

Germany OECD .69 Gault .65 Roy NA Smith et al. .74 H-L .67

United Kingdom OECD .60 Gault 41 Roy NA Smith et al. 35 H-L .46

France OECD 75 Gault .64 H-L -62

Italy OECD 66 Gault 55 H-L 71

»65 . 66 .50 75 .68

-59 42 35 . 36 -47

72 .65 . 63

- 63

-59 .

.76

.70 71

NA 71 74

.59 -43

NA .35 47

77 .70 .70

.62 .60 77

1980 65 72 75 .67

275 .79 75

NA .81

.56 .42 .37

NA -46

.88 .82 .78

75 .70 .90

1984 .69 .81 NA 71

.70 .78 NA NA 79

.58 -46 NA NA .o1

.82 .85 76

.67 .70 .98

NA _77 NA NA 77

NA - 46 NA NA .49

NA .83 .76

NA .67 .93

» 1.0)

—_--- ————— Se er

Sources: OECD (1987)

Gault (1986)

Roy (1982)

Smith et al. H-L: Hooper-Larin (present study)

(1982)

-25-

Table 7

Alternative Estimates of Unit Labor Costs in dollars 1980 eee eee estimates of Unit Labor Costs in dollars 1980

(Indexed to U.S. Unit Labor Cost = 100)

OECD Gault Roy 4H-B-c H-L Avg. Japan 87 79 76 65 86 79 Germany 166 159 135 120 154 147 France 103 111 128 -- 116 115 UK 136 180 204 -- 163 171 Italy 109 116 115 -- 90 108 Korea -- 60 -- -- 64 62

,

- 26 -

Chart 4 illustrates the widest range of estimates of relative unit labor costs we could find for Japan and Germany for the years 1980 through 1988. Estimates from other studies were extended through 1987 using the BLS indexes of output per hour and compensation. Figures for 1988 were estimated using actual exchange rates (during January - July), and assuming growth rates of productivity and compensation would continue at the average annual rate from 1980 to 1987. At the top of the range is the OECD study, which used internally generated manufacturing FPPs for 1984. The two studies at the bottom of the range, Gault (dotted line) and Hickok et al. (dashed line), used 1975 ICP PPPs to calculate their base year estimates, which can explain some of the difference between their estimates and our own. The low estimate of Hickok et al. can also be attributed in part to the use of unadjusted data for hours worked for the United States and data for hours paid for foreign countries, which understates the difference in unit labor costs. Chart 5 shows a comparison of our own estimates using both 1975 and 1980 PPPs. In the case of Japan, the 1975-based ULC ratio is noticeably below the 1980based ratio, which is ‘consistent with the difference between our estimate and the two lower estimates for Japan (Gault and Hickok et al.) shown in Chart 4, In addition to differences in base year PPPs, Gault used a narrower range of expenditure categories to represent manufacturing in computing his PPPs than we did, while Hickok et al. used a slightly broader range (which included government purchases of goods). Minor differences in sources for other data may account for some of the variation in Chart 4, but that variation is probably due mainly to the differences in PPP exchange rates used. In any event, while the actual

levels of foreign unit labor costs relative to the United States fell

Chart 4

Alternative Estimates of Relative Unit Labor Costs (U.S. = 100)

Germany

250

200

150

100

1982 1985 1988 1982 1985 1988

Sources: Gault (1988); Hickok, Bell, and Cegiowski (1987); Hooper-Larin (present study); OECD (1987).

-28-

Chart 5

Relative Unit Labor Costs Using Alternative PPP Exchange Rates

Japan

1980 PPP ———-1975 PPP

France

1980 PPP —— — -1975 PPP

1968

1978

(U.S. = 100)

150

120

60

30

180 150

120

60

30 1988

Germany 250 1980 PPP ——— -1975 PPP 200 tA 150 ~ 100 50 1968 1973 1988

Italy 150

1980 PPP ———-1975 PPP

120

30 1968 1978 1988

- 29 -

within a significant range, all of the studies indicate that German unit labor costs were well above U.S. costs, while Japanese costs rose

slightly to moderately above U.S. costs during 1987-early 1988.

V. Conclusions

In this paper we have reviewed a number of earlier efforts to measure the relative levels of labor costs and labor productivity across countries, and we have provided an updated set of estimates of our own. Or. the basis of this review and our own empirical analysis, we draw the following conclusions:

1. Relative levels of average labor compensation in menufacturing have differed significantly across countries in recent years. To a certain extent, these differences have reflected differences in levels of Labor productivity.

2. Most empirical estimates (including our own) suggest that the level of U.S. unit labor costs in manufacturing (i.e., compensation divided by productivity), has fluctuated both above and below average unit labor costs in other major industrial countries over the past decade. As of early 1988, the U.S. level appeared to be well below the foreign average level.

3. Unit labor costs in at least one newly industrializing country (Korea) appear to remain well below those in industrial countries.

4. Over the past 15 years of generally floating exchange rates, movements in relative unit labor costs over time have been determined

predominantly by swings in nominal exchange rates. That the U.S. level

- 30 -

has fallen below the average level in other major industrial countries is primarily the result of the 35 percent depreciation of the dollar against the currencies of those countries between early 1985 and early 1938.

5. Movements in relative productivity had a noticeable impact on relative unit labor costs in the 1960s and early 1970s. Since then, however, differences in productivity trends between the United States and other industrial countries on average have been much less pronounced, and have contributed little to shifts in relative unit labor costs.

6. The various studies we have surveyed -- including our own -generally agree about directions of change and even relative levels of unit labor costs and productivity across countries. However, they do present a range of estimates, reflecting a variety of different estimation techniques. In view of this range, and in view of the © inherent difficulties involved in obtaining sufficiently reliable data in some areas for these types of calculations, these empirical estimates

should be used with caution.

-31-

References

Bank of Korea. Montaly Statistica: Bulletin.

Baunol, William J. and Kenneth McLennan, eds. Productivity Growth and U.S Competitiveness. New York: Oxford University Press. 1985.

Bergson, Abram, "Comparative Productivity: the USSR, Eastern Europe, and

the West" The American Economic Review. vol. 77 (June 1987), pp. 342-357.

Christensen, L.R., D. Cummings, and D.W. Jorgenson. "Relative Productivity Levels, 1947-1973: An International Comparison" European Economic Review. vol. 16 (May 1981), pp. 61-94.

Gault, Nigel. The Competitiveness of U.S. Manufacturing Industry: Inter:.ational Comparisons of Labor, Energy, and Capital Costs.

Cambridge, Massachusetts: Data Resources, Inc. 1986.

Hickok, S., L. Bell, J. Ceglowski, "U.S. Manufactured Goods Competitiveness: Recent Changes and Future Prospects," forthcoming, 1988.

Hill, Peter. Real Gross Product in OECD Countries and Associated Purchasing Power Parities. OECD Economics and Statistics Department Working Papers #17. December 1984.

. "International Price Levels and Purchasing Power Parities," from OECD Economic Studies, #6 (Spring 1986).

International Labour Office. Yearbook of Labour Statistics. Geneva: 1983.

Isard, Peter, "How far can we push the ‘law of one price’?" American Economic Review, vol. 67 (December 1977), pp. 937-948.

Kendrick, John W. ed. International Comparisons of Productivity and Causes of the Slowdown. Cambridge, Massachusetts: Ballinger Publishing Company. 1984.

Kravis, I.B. "A Survey of International Comparisons of Productivity” Economic Journal. vol. 86 (March 1976), pp. 1-44.

Kravis, Irving B., Alan W. Heston, and Robert Summers. International

Comparisons of Real Product and Purchasing Power. Baltimore: Johns Hopkins University Press. 1978.

. World Product and Income; Internatio Comparisons of Real Gross Product. Baltimore: Johns Hopkins University Press. 1982.

Kravis, Irving B, Zoltan Kenessey, Alan W. Heston, and Robert Summers. A System of International Comparisons of Gross Product and Purchasing Power. Baltimore: Johns Hopkins University Press. 1975.

- 32 -

Neef, Arthur and James Thomas. "Trends in Manufacturing Productivity and Labor Costs in the U.S. and Abroad" Monthly Labor Review. (December 1987), pp. 25-30.

Organization of Economic Cooperation and Development. OECD Economic Qutlook. #42 (December 1987), p. 45. And additional unpublished data °

Paige, D. and G. Brombach. A Comparison of National Output and Productivity of the UK, and the US. Paris: 1959.

Roy, A.D. "Labour Productivity in 1980: An International Comparison," National Institute Economic Review, #101 (August 1982), pp. 26- 37.

Smith, A.D., D.M.W.N. Hitchens, S.W. Davies. International Industria]

Productivity: A Comparison of Britain, America, and Germany. Cambridge University Press, 1982.

United Nations: Commission of the European Communities. World Comparisons

of Purchasing Power and Real Product for 1980. New York: United Nations, 1987.

United States Department of Labor. Bureau of Labor Statistics. "International Comparisons of Hourly Compensation Costs for

Production Workers in Manufacturing, 1987," Report 750, February 1988.

IFDP NUMBE:

iW

328

327

326

325

324

323

322

321

320

319

318

- 33 -

International Finance Discussion Papers

International Comparisons of Labor Costs in Manufacturing

Interactions Between Domestic and Foreign Investment

The Timing of Consumer Arrivals in Edgeworth’s Duopoly Model

Competition by Choice

The Determinants of the Growth of

Multinational Banking Organizations: 1972-86

Econometric Modeling of Consumers’ Expenditure in Venezuela

Income and Price Elasticities of Foreign Trade Flows: Econometric Estimation and Analysis of the US Trade Deficit

Money, Interest, and Capital in a Cash-in-Advance Economy

The Simultaneous Equations Model with Generalized Autoregressive Conditional Heteroskedasticity: The SEM-GARCH Model

Adjustment Costs and International Trade Dynamics

The Capital Flight "Problem"

1987

Modeling Investment Income and Other Services in the U.S. International Transactions Accounts

Improving the Forecast Accuracy of Provisional Data: An Application of the Kalman Filter to Retail Sales Estimates

AUTHOR(s)

Peter Hooper Kathryn A. Larin

Guy V.G. Stevens Robert E. Lipsey Mare Dudey

Marc Dudey Robert S. Dohner Henry S. Terrell Julia Campos Neil R. Ericsson Jaime Marquez

Wilbur John Coleman II

Richard Harmon

Joseph E. Gagnon

David B. Gordon Ross Levine

William Helkie Lois Stekler

B. Dianne Pauls

Please address requests for copies to International Finance Discussion Papers, Division of International Finance, Stop 24, Board of Governors of the

Federal Reserve System, Washington, D.C.

20551.

IFDP NUMBER

317

315 314

313 312

311

310

309 308 307 306 305 304 303

302

- 34 -

International Finance Discussion Papers

TITLES

Monte Carlo Methodology and the Finite Sample Properties of Statistics for Testing Nested and Non-Nested Hypotheses

The U.S. External Deficit: Its Causes and Persistence

Debt Conversions: Economic Issues for Heavily Indebted Developing Countries

Exchange Rate Regimes and Macroeconomic Stabilization in a Developing Country

Monetary Policy in Taiwan, China

The Pricing of Forward Exchange Rates Realignment of the Yen-Dollar Exchange Rate: Aspects of the Adjustment Process in Japan

The Effect of Multilateral Trade Clearinghouses on the Demand for

International Reserves

Protection and Retaliation: the Rules of the Game

Changing International Duopoly with Tariffs A Simple Simulation Model ‘of International

Bank Lending

A Reassessment of Measures of the Dollar's Effective Exchange Value

Macroeconomic Instability of the Less Developed Country Economy when Bank Credit is Rationed

The U.S. External Deficit in the 1980s: An Empirical Analysis

An Analogue Model of Phase-Averaging Procedures

A Model of Exchange Rate Pass-Through

AUTHOR(s)

Neil R. Ericsson

Peter Hooper Catherine L. Mann

Lewis S. Alexander

David H. Howard

Robert F. Emery Ross Levine Bonnie E. Loopesko

Robert E. Johnson

Ellen E. Meade

Catherine ]L. Mann

Eric O'N. /Fisher Charles A. Wilson

Henry S. Terrell Robert S. Dohner

B. Dianne ?auls William L. Helkie

David F. Spigelman

William L. Helkie Peter Hooper

Julia Campos Neil R. Ericsson David F. Hendry

Eric O’N. Fisher