Unit Labour Cost as an Indicator of Competitiveness: Theoretical Perspectives on Reconciling Methodological Challenges

What the paper says

For decades, economists have faced the dilemma of identifying the key factor in export competitiveness. While some argue that exports are almost exclusively influenced by non-price competitiveness, others emphasise the importance of cost competitiveness and highlight unit labour cost (ULC) as a key factor. Based on a systematic review of the literature, this paper concludes that cost competitiveness, as measured by ULC, is an important determinant of the export performance of firms, sectors and economies, but has significant limitations. The methodological difficulties in assessing this relationship are analysed, and suggestions for improvement and guidelines for future research are provided. Although the traditional ULC is a biased indicator, newer indicators do not address all of its shortcomings. Microeconomic studies generally confirm a negative relationship between exports and ULC, but it is important to control for product quality in order to improve estimates. Although the methodological approach has progressed, fully controlling for endogeneity remains a challenge, and the results are still subject to limitations. This paper suggests that using value added instead of gross exports and indicators such as vertically integrated ULC would improve the accuracy of the estimates and reduce the bias in the results. It also emphasises the importance of shocks that precede changes in ULC and the possibility that long-term deviations from the ULC trend significantly affect exports. The relationship between ULC and exports is multi-faceted and complex, and is subject to methodological challenges such as endogeneity, simultaneity and shocks affecting the economy, sector or firm, which need to be isolated when assessing and interpreting the results.