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Wage cuts may hurt growth

Cutting wages tends to increase competitiveness but can also hurt economic growth as it decreases domestic consumption, the International Labour Organization has warned.

News | 10 August 2012
GENEVA (ILO News) - The ILO has warned that slashing wages in a bid to boost competitiveness and cut unemployment may well have the opposite effect.

The warning was issued after the European Central Bank (ECB) called in its monthly report for August, for more flexibility in the wage determination process - such as lowering minimum wages - coupled with measures to strengthen competitiveness.

A decrease in wages does tend to lead to an increase in exports, but it also depresses domestic consumption, which affects growth, ILO experts say. Given the level of economic uncertainty at the moment, it is also unclear whether wage cuts would generate enough incentives to raise investment.

“Whenever a fall in wages reduces domestic consumption more than it increases exports and investment, it has a negative effect on a country’s economic growth,” said Patrick Belser, a senior economist at the ILO’s Conditions of Work and Employment Branch and main editor of the ILO Global Wage Report.

“This explains why declining wages in periods of crisis may actually lead to a spiral of falling aggregate demand and price deflation, rather than to a quicker economic recovery,” he added.
If competitive wage cuts are pursued simultaneously in all countries, competitive gains will cancel out."

The ILO also warned that seeking to regain competitiveness through lower unit labour costs – by slashing wages or letting productivity grow faster than wages – would be unsustainable globally.

“If competitive wage cuts are pursued simultaneously in all countries, competitive gains will cancel out and the regressive effect of global wage cuts on consumption could lead to a world-wide depression of aggregate demand and employment,” Belser said.

Wage growth that is systematically above labour productivity growth is unsustainable. The opposite is also true. “The aim is for wages and productivity to grow at the same pace,” concluded Belser.

Journalists needing more information, please contact ILO spokesperson Hans von Rohland +4122/799-7916,