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.