The National Statistics Office has published the labour cost index for the second quarter of this year. The data also provides information on the progression of the amount of hours worked and the total compensation paid by employers for the period covering the years 2001-2005. The data also provides information for different economic activities.

The data reflects the restructuring taking place in the economy in general and, more specifically, developments in the labour market. On the basis of this data, there should be no doubt that the labour market is buoyant and the economy has proved itself to be resilient in the face of an international economic slowdown that has characterised the first years of this century.

The NSO data indicates the way wages and salaries and employers' social security contributions have progressed, to provide a total compensation index. This is then correlated to the number of hours worked, to calculate the labour cost index, thus based on the labour cost per hour. The progression of wages and salaries is determined by four factors:

¤ the cost of living adjustments established through a formula that has been agreed upon among the social partners;

¤ collective bargaining between employers and trade unions;

¤ the performance of the company and of the individual employees; and

¤ supply and demand conditions in the labour market.

The cost of living adjustment formula has been in place for the last 15 years or so. It has worked well, even if it has certain defects, depending upon from which perspective one is looking at things. Trade unions would complain that the basis on which it is calculated needs to be updated more regularly and that we should take into account the average wage rather than the so-called social wage. Employers seem to be quite satisfied with the cost of living adjustment formula but they claim that it should not be divorced from other wage adjustments that may arise from the collective bargaining process.

This would bring us to the second factor that determines wages and salaries. In this country we have a collective agreement increase and a cost of living adjustment. This would mean that, in companies where there does exist a collective agreement, the increase in wages and salaries is not necessarily tied to productivity increases. This would result in a loss of competitiveness for such firms.

In the private sector, employers tend to feel that trade unions tend to be quite reasonable, also as a result of pressure from their own members, who fear for their jobs if the companies they work with lose competitiveness.

It is a totally different situation in the public sector, where there is very little to no correlation between collective agreement increases and productivity increases. Collective agreements, although still having an important role in the labour market, seem to be playing a less significant role than say 20 or 30 years ago.

On the other hand, productivity increases, in whatever way they are measured, tend to play a very significant role in the determination of wages resulting from company performance and the performance of the individual employees. This is where the concept of performance-related pay acquires substance and is concretised.

From a purely economic perspective, this method of establishing wages and salaries is very appropriate, logical and even fair. Essentially, employees would only get an increase in their salary if they perform well and if the corporate result is satisfactory. Employees that do not perform would get no increase.

This method would help the company to sustain its competitiveness. The method of remuneration is most certainly gaining ground in this country.

Then there is the aspect of supply and demand conditions in the labour market. Whenever there is a shortage in the labour market for a particular skill, employers would tend to be willing to offer higher wages for that skill, either to retain their existing talent or to attract new talent.

On the other hand, whenever there is a surplus of a particular skill, wages would tend to be dampened. The problem with all this is that wages (like in most prices for a product or for a factor of production) tend to be very flexible upwards and very sticky downwards. So skill shortages tend to push wages upwards, but skill surpluses do not necessarily push wages downwards.

The restructuring that has been taking place in the last 20 years in our economy has meant that certain economic activities had no longer any justification for them to remain in Malta, while new ones have been set up. Others have changed beyond recognition, such as financial services. This has obviously reflected itself in the labour costs index.

Thus, although overall between 2001 and 2005, the index rose by 13.2 per cent, an increase that is well above the cost of living adjustment, the index for certain economic activities moved very little. The overall index for total compensation increased by 12.2 per cent while the index for hours worked increased by 5.8 per cent.

The sectors that experienced the highest increase in the labour costs index were those of financial services, manufacturing, construction and the distributive trades. This is fairly evident of the increase in activity that has been taking place in these sectors, as well as the transformation that these sectors are going through. This may also be a reflection of an element of skill shortages in these sectors.

Labour costs are like a double-edged sword. An unreasonable increase in labour costs may render certain business activities unsustainable and hence a threat to employment. On the other hand, a country that experiences increases in labour costs is an indication of an economy that is moving forward.

There is an equilibrium that needs to be achieved between labour costs and unemployment/employment.

This equilibrium can only be achieved if there is a thorough understanding by all concerned of how wages can be used as a tool not to destroy competitiveness but as a tool to increase productivity.