Feature article: Analytical measures in the Australian National Accounts
Australia has had sustained economic growth for the past twenty seven years and is currently experiencing solid labour market growth (as measured by employment) in contrast to subdued Gross Domestic Product (GDP) growth. This article examines the analytical series produced in the National Accounts by describing different measures to determine best use for analytical purposes, particularly the usefulness in analysing the cost of labour relative to growth in income.
GDP per capita slows over the past four quarters
GDP is the measure of the value added generated in Australia through the production of goods and services in a quarter, which is equivalent to the income earned from that production.
Real GDP per capita is defined as:
Where GDP chain volume measure reflects the total production generated by economic activity in Australia and the estimated resident population is the official measure of Australia’s total resident population. Interpreting changes in this measure will determine if Australia has the productive capacity to meet the needs of its population growth. Negative movements indicate that the population growth is outpacing economic growth, and hence spare capacity might exist in the economy. Whereas a positive movement indicates that productive capacity is met.
A decomposition of the population to those working allows analysis of the production linkages to productive resources (the working population), therefore analysis of the ratio of GDP to hours worked.
GDP per hour worked is negative for four consecutive quarters
Real GDP per hour worked is defined as:
Where hours worked are derived as the average hours worked for the employed population (including Defence).
This series is commonly interpreted as changes in labour productivity. A fall in GDP per hour worked indicates less output is produced for every hour worked and a rise indicates increased output is produced per hour worked. However, GDP does not solely represent the labour contribution to the production process but also the contribution of capital and other factors (such as managerial efficiency, economies of scale, etc.) to the production process. To analyse this series it should be noted that this estimate only accounts for the contribution of the labour component (hours worked) to changes in production per hour worked.
Therefore, by design, this estimate alone may not indicate how productive the labour force is or how utilised the labour component is in the production process. To understand the labour component in conjunction with the production process it is more insightful to analyse the cost of labour relative to output.
Cost of labour relative to output
The National Accounts produce four indicators of labour costs including compensation of employees, average compensation of employees, unit labour costs and real unit labour costs. These are useful to analyse how the cost of labour drives growth in our economy.
Compensation of employees (COE)
COE is a National Accounts measure of labour cost that comprises wages and salaries (in cash and in kind) and employers’ social contributions. COE does not include any unpaid work undertaken voluntarily or any taxes payable by the employer on the wage and salary bill such as payroll tax though it does include fringe benefits tax.
COE provides a wider measure than employee earnings as it includes severance and termination payments, all irregular remuneration such as irregular bonuses and exceptional payments.
While a change in COE does take into consideration changes in composition of jobs or hours worked, it does not take into account the affect productivity changes have on labour costs.
Average COE per employee
Average COE per employee, known as Average Earnings National Accounts (AENA), is defined as:
AENA is designed to measure the average level of labour cost per employee.
Compositional changes in the workforce affect AENA, that is, circumstances such as increases in the proportion of higher paid or full time jobs will increase AENA when keeping all other influences constant. While AENA captures compositional changes in the workforce, it does not take into account impacts productivity improvements may have on labour costs so changes in hours worked will impact this estimate.
In contrast to changes reflected in AENA, unit labour costs (ULC) allow for analysis of changes in labour costs associated with a change in labour productivity.
Unit labour costs
ULC are an indicator of the average cost of labour per unit of output produced in the economy. This implies unit labour costs associated with the employment of labour adjusted for labour productivity.
Unit labour costs are defined as:
Average labour costs are defined as:
Average labour productivity is defined as:
Total hours worked includes hours worked by employees, employers and self-employed. ALP is derived using total hours worked as it is not possible to decompose GVA by employees only.
The benefit of analysing ULC is that it indicates returns from labour inputs into economic production as it accounts for labour productivity. As a result, if there is an increase in average labour costs and there is a corresponding increase in labour productivity there will be no change in ULC. A rise in ULC indicates increased reward for the labour contribution to output. However, a fall in ULC may indicate increased cost competitiveness, if other costs are not adjusted in compensation. Labour costs as an input into production are important but it should be noted that this measure does not account for the changes in costs of capital.
ULC analysis shows the effect that productivity has on labour costs in terms of the cost per unit of output, hence the amount of output relative to wages or labour costs. This is a nominal measure. To account for changes driven by change in price the real unit labour cost (RULC) should be analysed.
Real unit labour costs
Nominal unit labour costs are subject to general price changes across the economy. RULC removes the impact of general price changes and measures direct labour cost pressures associated with the employment of labour.
General price changes are removed by deflating average labour cost.
Real unit labour costs are defined as:
The choice of deflator is important to effectively use RULC as an indicator for measuring labour costs. A suitable deflator should represent producer prices to appropriately measure the cost of labour. If the deflator reflected consumer prices it would instead measure the purchasing power of wages.
The GDP implicit price deflator is preferred as its scope directly relates to the production of goods and services. The GDP deflator also reflects any changes to the terms of trade. As Australia’s terms of trade can be volatile, the growth in RULC may be masked as the GDP deflator may overstate or understate growth in prices faced by domestic producers. Domestic value of production determines employers’ ability to meet wage bill obligations opposed to their purchasing power equivalent. For this reason, alternate measures such as the domestic final demand (DFD) deflator can be considered when determining the appropriate deflator. However, while it is true that for producers who compete against relatively cheaper imports the GDP deflator may not be ideal, it is also the case that exporting producers will see relative increase in prices for their outputs. Overall, the GDP deflator is the most appropriate broad measure of price change as it affects domestic producers and hence, even in times when the terms of trade are changing rapidly, the RULC is compiled using the GDP deflator.
RULC takes into account productivity and general inflation when measuring average labour costs. By taking into account these factors, RULC indicates whether ‘excess’ labour cost growth may create cost pressures within the economy and drive changes to economic growth.
The different analytical measures of labour cost discussed in the paper are required for understanding economic and social development. The differing uses of these statistics indicate that a single all-encompassing measure cannot satisfy all measurement needs. The range of analytical measures need to be interpreted carefully and used appropriately to provide insights in to the current economic landscape.