Labour costs pass-through, profits and rebalancing in vulnerable Member States

This section discusses whether the incomplete pass-through of labour cost moderation into prices observed in some vulnerable countries in the last few years is reflected into profitability developments and whether this is favourable to external rebalancing in vulnerable euro area Member States. In accounting terms, broadly defined measures of operating profits are the link between labour costs and the gross value-added deflators. Macro- and micro-level data are used to better understand the drivers of recent increases in profit measures relative to labour costs. The results suggest that profit margins (gross operating surplus over value-added) increased ñ particularly in tradable industries ñ thus absorbing part of the reduction in unit labour costs. However, higher profit margins were not sufficient to contain downward pressures on profitability measured in terms of return on assets, due to surging funding pressures and falling capital productivity. Still, data point to a relative increase of profitability in the tradable sector that is desirable in order to incentivise the reallocation of resources into export oriented industries, thus contributing to external rebalancing within the euro area.