This paper investigates the relationship between the relative positions, in terms of value added and relative prices, of Belgian manufacturing and market services in the European Union over 1970-2005. Relative prices are then broken down into relative unit costs of production factors. The analysis goes further by decomposing relative unit labour cost into relative hourly wages and relative productivity. Finally, relative productivity is broken down into relative capital deepening, relative labour
composition effect and relative total factor productivity.
The re-appearance of a current account deficit during the last few years has again focused attention on the determinants of competitiveness. In order to provide a complementary light to the traditional approach, which is based on the analysis of relative export performances, an alternative approach is developed in this Working Paper. This approach is based on the evolution of the share of Belgian industries in the total value added of the European Union (EU15). Indeed, the aim is not to gain export market shares if the content of exports in local value added decreases because exporters make greater calls on foreign suppliers. The reason for maintaining the competitive position of an economy is, indeed, rooted in the need to keep value added creation inside the country’s borders in order to guarantee economic growth.
The first determinant of relative value added is relative value added deflators. The intuitive assumption, based on economic theory, is that decreasing prices below European ones allows industries to increase the share of European value added created in Belgium. The econometric results indicate that, over 1970-2005, this was indeed the case for manufacturing and market services. This negative relationship was, however, more pronounced for manufacturing industries than for market services, which confirms the assumption that competition is more pronounced for manufacturing than for market services.
The second series of determinants is linked to the main components of value added price evolution: the unit costs of production factors, labour and capital. The effect of relative unit labour cost is econometrically significant for manufacturing and for market services, with a higher elasticity for manufacturing than for market services.
The third series of determinants is obtained by the decomposition of the relative unit labour cost into relative hourly wages and relative productivity. Relative productivity is clearly the main determinant for manufacturing, with an elasticity equal to double the elasticity of relative hourly wages.
The last series of determinants is based on the identification of the three factors influencing productivity growth: capital deepening, labour composition effect and total factor productivity (TFP). The results underline the importance of relative TFP as a determinant of the relative European position of manufacturing and market services.
From an economic policy point of view, the analysis shows that the law in favour of the promotion of growth and the safeguarding of competitiveness has allowed a stabilisation of relative wages. Econometric results justify the implementation of this law with the importance of the relative unit labour cost elasticity. These results also underline the importance of taking into account the two parts of labour cost: the hourly wage and productivity.
In the long run, policies designed to promote productivity and, in particular, TFP gains have a larger impact than wage moderation policies. However, these policies are more difficult to define and implement. A better understanding of TFP determinants in order to define the most efficient instruments could therefore be a crucial step forward in any future research programme.