Replacing capital with labour may help reduce the persisting unemployment

Even though several analysts were pessimistic regarding improved employment after the summer months, unemployment continued to abate in September as well. The registered unemployment rate dropped even a little more than in July and August: by 0.4 percentage points, decreasing to 14.6% of the economically active population by the end of the month.

Albeit the number of vacancies in the registers of the State Employment Agency (NVA) shrank somewhat in September (to 3.4 thousand) as seasonal jobs closed, the number of unemployed who found regular employment grew to 7.1 thousand, supporting the Bank of Latvia predictions that there would be no substantial rise in unemployment in autumn.

The rise in employment is likely to be determined not only because of the first signs of economic recovery but also a short-term replacement of capital with labour in enterprises. The hourly labour costs in Latvia have substantially gone down since the beginning of the crisis, particularly among the less qualified labour force. Businesses can thus hire less qualified employees for wages that are much lower than a couple of years ago as also evidenced by the persisting queues for employment in the 100-lats programme. Under the influence of the global economic recovery¹ the costs of capital investments have stabilized and a small rise in prices is observed in some segments. The drop in labour costs as compared to the prices of manufacturing equipment could thus increase the demand for labour. The demand for labour could also be promoted by the uneven dynamics of the industrial output and the volume of new orders. The confidence data of the European Commission indicate that while the production volumes are rising, the future outlook of the Latvian business men is still cautious. In these conditions, entrepreneurs are not rushing to make long-term investment in manufacturing equipment and may prefer increasing the number of employees to ensure output growth.

Up to now, entrepreneurs tended to require highly qualified employees, using the opportunities to attract top talent for comparatively low wages. In future, however, entrepreneurs may be more alive to the possibility that, in the short run, it may be more to their advantage to attract less qualified employees instead of renovating the expensive manufacturing equipment (metaphorically speaking, it may become more profitable to dig ditches with spades instead of tractors). That could have a positive effect on employment in the less qualified segment, which was most affected by layoffs during the crisis. Even though the above factor would provide a short-term solution, a side effect could be the drop in structural unemployment in the long term. It is well known that the longer a person is without a job, the more he or she loses their skills, which is even more detrimental to his or her prospects of finding a job. A short-term replacement of capital with labour in enterprises may thus help jobseekers to retain their skills and that would be very important in promoting a sustainable economic growth.

¹ This is indicated both by the positive deflationary annual changes in share capital formation in the second quarter of 2010 when the deflationary trend in consumer prices remained downward pointing and the stabilization of construction costs (which previously affected the construction costs of industrial, agricultural, and commercial buildings first) as well as the rise in imported mechanical equipment and electronics, which has been steeper than the average rise in the prices of imported goods.