An Export-Based Measure of Competitiveness

Unit labor cost (ULC) developments have been receiving increased attention from policymakers throughout the euro area, as adverse developments in price competitiveness are commonly seen as one of the causes of the ongoing sovereign debt crisis in the euro area. Yet empirical results are often ambiguous on the link between ULC developments and export performance. This widely examined empirical conundrum, often referred to as “Kaldor paradox,” naturally raises the question whether commonly used measures of ULC growth (such as total economy ULC) are a meaningful measure of mounting imbalances and persistent losses of trade competitiveness. Therefore, we propose a new ULC growth index that exploits disaggregated sectoral information and focuses on export-relevant sectors only. This trade-weighted ULC index is shown to have a substantially higher explanatory power for export growth than traditional ULC measures.