Wage growth raises purchasing power, which may promote private consumption recovery

The rate of wage growth accelerated at the beginning of this year, with the average gross monthly salary for full time work reaching 452 lats and the rate of its annual growth at 4.6%.

In the public sector, a faster rate of wage growth (6.4%) was to a great extent determined by the partial compensation, as from the end of 2010, for the cuts in teachers' salaries made at the beginning of 2009./2010 school year. Wage increase in public administration (5.9%) were probably achieved by continuing with the layoffs of lower qualified officials [1], (when low-qualified and low-salaried employees are dismissed, the average salary goes up even if no one receives a raise), as well as by compensating the rapid cuts in salaries to some high qualified specialists. An acceleration in salary growth was observed also in the private sector (3.6%), which was substantially determined by the increase in minimum wage by 11% (up to LVL 200) at the beginning of this year: the largest part of minimum wage recipients work for the private sector, partly reflecting the prevalence of envelope wages.  

Moreover, for the first time in nine quarters, the real net salary for full-time work also grew year-on-year (by 0.1%). Thus an end was put to the trend observed in 2009 and 2010 when fewer and fewer goods and services on average could be obtained for an hour's work. A relatively slow rate of real net salary growth was determined by a short-term rise in inflation – mostly effected by the increase in global oil and food prices as well as by the tax wedge on labour income or widening gap between gross and net wages since the beginning of 2011 [2], which already was one of the highest in the EU.

As new work places appear in the country and employees gradually return to full-time from the cut workload of the crisis period, the increase in wage bill exceeds inflation, thus increasing purchasing power. Since income from work is the main component of the disposable income of households, it may have a significant impact on the dynamics of private consumption. Thus it is possible that GDP growth which was recently driven by net export developments will be promoted this year by domestic demand as well. If the behaviour of households does not change, however (according to the data of a consumer trend survey, most households still do not predict an improvement in either the economic situation of the country or the financial capacity of their own families and are reluctant to large purchases), it would be premature to predict a sustained rise in private consumption, particularly in view of the consumption tax increases: in the coming months, fluctuations in retail turnover are likely to continue.

Wage growth is expected to remain moderate and being broadly in line with increased productivity. The unsustainable wage rises in 2006–2008, which dampened the competitiveness of the economy was reversed afterwards: the average wage rate in the country is broadly consistent with the level of labour productivity.  That helped to restore competitiveness of the economy and to compensate the drop in domestic demand with a robust rise in exports as early as in 2010, thus, creating new jobs. It should be noted that given high unemployment the risk of inflation second-round effects (or the impact of global oil and food price increase on wage expectations, which heat up the inflation) will remain minimal. Thus, policy makers should not fear wage growth if it goes hand in hand with increase in productivity; sustainable development of the economy and the growth of real income (including salaries) are two sides of the same coin: one is unthinkable without the other.  

[1] The number of jobs in public administration dropped in previous quarters; at the same time, representatives of publicinstitutions emphasized the need to retain the best employees.

[2] Even though the personal income tax rate dropped by one percentage point as from 2011, the keyrate of social insurance payments of employees grew by two percentage points. 

APA: Krasnopjorovs, O. (2019, 13. sep.). Wage growth raises purchasing power, which may promote private consumption recovery. Taken from https://www.macroeconomics.lv/node/2331
MLA: Krasnopjorovs, Oļegs. "Wage growth raises purchasing power, which may promote private consumption recovery" www.macroeconomics.lv. Tīmeklis. 13.09.2019. <https://www.macroeconomics.lv/node/2331>.

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