Sunday, September 23, 2012

The Uses of Fake GDP (2): Unit Labor Cost

I looked at "Unit Labor Cost" the other day. According to, ULC is calculated as "total labor costs (including benefits)" divided by "real output".

Wikipedia has a problem with that. Under Compensation of Employees (CE) it says:

The main criticisms made of the accounting concept of CE are that it can make workers' incomes look larger than they truly are, and that the main components of CE are not separately itemised in the accounts. What CE really contains is not made explicit.

Often economists confuse CE with the total wage bill of a country, which is false. They might use CE to strike a quick "wages-profits ratio" or calculate unit labor costs, without realising what they are really doing. CE is not equal to gross wages, or real disposable income of workers, nor - strictly speaking - total labour costs.

I dunno. The OECD's definition pretty much agrees with

Unit labour costs (ULC) measure the average cost of labour per unit of output and are calculated as the ratio of total labour costs to real output.

OECD seems not to define "total labour cost" but does define Labour Cost:

Labour cost is defined as the total expenditure borne by employers in order to employ workers, a concept which has been adopted in the Community framework and complies broadly with the international definition of the International Conference of Labour Statisticians (Geneva, 1966).

Again, it seems to agree with And it seems to be "the total" labor cost. I think I have to dismiss the objections of the Wikipedia article.

Now about that calculation: Add up all the costs you can associate with labor, and divide it by GDP. Oh -- no, that's wrong. Divide it by real GDP.

So they take a cost number and an output number, make them into a ratio, and then reduce the denominator to account for inflation. The value of the ratio must therefore be skewed upward on an inflation-like path. That is a blatant falsification of the facts.

Why bother to divide inflation out of the denominator? Why not just multiply the ratio by inflation directly? You'd get the same result.

The Wikipedia article has all sorts of complaints about the calculation. But apart from economists' confusion, the main complaint seems to be that CE "can make workers' incomes look larger than they truly are".

Sheesh. If I try to get a job that pays $10 an hour, but the employer has to pay a total of, say, $25 an hour if they hire me, then $25 is the number that determines whether anyone gets hired. If you're concerned about employment -- or unemployment -- the total labor cost number is the number you have to watch.

The Wikipedia article is pretty bad. But it's almost right about one thing. Something is made to look larger than it really is. But it's not total labor cost. It is the ULC, the Unit Labor Cost, that is made to look falsely large. But this is not accomplished by counting the costs associated with labor.

It is accomplished by stripping inflation out of the denominator of the Unit Labor Cost calculation. This mathematical deception is guaranteed to make labor costs look as if they are increasing on a path similar to inflation. When the deception is not used, it is easy to see that Unit Labor Cost is falling and has been falling for half a century.

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