Business sector can sustain wage increases of 3.5–4.2 percent, but lower wage increases will mean more jobs

The Swedish economy is continuing to recover. With productivity still rising, the business sector is considered capable of affording annual increases in hourly earnings of 3.5-4.2 percent during 2006-2015, with considerable variations depending on the individual and the state of the economy. From a general economic standpoint, however, smaller wage increases are desirable since they will result in lower unemployment and higher GDP.

If the labour supply does not increase, and unemployment does not decrease, more than in the main scenario, it will then be necessary to raise taxes or reduce the expenditure of welfare systems by some SEK 8 billion per year in order to achieve the targeted surplus of 2 percent in general government net lending.

The prolonged cyclical weaknening of the labour market ceased in the second quarter of this year, when the number of hours worked began rising. Employment will increase by 1.0 percent in 2006 and 0.7 percent in 2007. The unemployment rate will drop from 5.9 percent this year to 4.7 percent in 2007, partly because of the substantial increases in labour market programmes proposed in the budget bill. GDP will grow by 2.5 percent in 2005, 3.2 percent in 2006 and 2.8 percent in 2007. A gradually tightening labour market will mean larger wage increases and slowly rising inflationary pressure. Monetary policy is currently well balanced. If the labour market and inflation develop as forecast, it will be appropriate to begin raising the repo rate in April 2006.

Swedish Business Sector Competitive

The payroll capacity of the business sector depends in part on the internationally required rate of return, since the latter determines the rate of return required for investment in Sweden. The return on investment in Sweden this year is considered to be internationally competitive; in other words, Swedish labour costs are in balance. This means that the relocation of jobs to low-cost countries is being offset by a corresponding increase in other jobs. Thus, the structural transformation of the Swedish business sector, which has been in progress for quite some time, will continue.

In the period 2006?2015, labour productivity is anticipated to increase by an annual average of 2.7 percent, somewhat less than in the 1990's but still stronger than in the 1980´s. In the period ahead, productivity growth in the Swedish business sector is expected to remain somewhat above the average for the country´s principal trading partners.

With productivity increasing so strongly, the business sector will be able to sustain annual increases in hourly earnings of some 4 percent, with substantial variations depending on the individual and the state of the economy. Under alternative realistic assumptions, the increase is estimated at between 3.5 and 4.2 percent per year. These rates are for the average payroll capacity of the business sector and include negotiated wage increases, wage increases above negotiated levels and reductions, if any, in work hours.

More Modest Wage Increases Would Help to Reduce Unemployment

As long as unemployment remains too high, however, smaller wage increases are desirable from a general economic standpoint since they would contribute to lower unemployment and higher GDP, and would create a margin for reducing taxes or increasing general government expenditure. On the other hand, if wages were to increase for three years at a rate one percent above the forecast, the consequences would be higher unemployment, as well as a loss of GDP totaling about SEK 40 billion, according to one calculation.

The development of wages in other countries is of lesser importance for the rate at which labour costs can increase in Sweden, as payroll capacity is effectively governed by the inflation target, not the exchange rate. At the industry and firm levels, however, comparisons of wages may be of considerable interest, for there the exchange rate can be viewed as given. The cost of labour is higher in Sweden than in the EU as a whole. While this difference contributes to structural transformation of the Swedish business sector, it does not give rise to a prolonged lack of demand for labour in Sweden as a whole.

Increased Labour Supply Needed to Maintain National Welfare Systems

According to a demographic projection, the number of hours worked will increase at an average annual trend rate of only 0.1 percent in the period 2006?2015. The explanation is the slow growth of the working-age population. Since labour productivity is forecast to rise by approximately 2.1 percent per year, the trend rate of increase in GDP will be about 2.2 percent per year.

Since the labour market is cyclically weak to begin with in 2005, it is estimated that in the main scenario the number of hours worked will increase by 0.3 percent and GDP will grow at an average annual rate of 2.5 percent during 2006-2015. If the number of hours worked increases as modestly as in the main scenario, higher taxes or cutbacks in welfare systems equivalent to about SEK 8 billion per year will be necessary to achieve the 2-percent target for general government net lending. To meet the commitments of Sweden's welfare systems without raising taxes or contributions, a substantially stronger increase in number of hours worked will be called for. The labour supply must be larger, and unemployment lower. The parties on the labour market can help by showing restraint in wage increases as long as unemployment is too high, and by promoting greater mobility between industries, regions and occupations.

Key Numbers

Annual percentage change and percent, respectively

(1) Calendar-adjusted (2) Average for year (3) In percent of GDP Sources: Statistics Sweden, Labour Market Board, the Riksbank and NIER