Unit labor costs are important indicators of the competitiveness of the cost of labor in a company or even an entire economy.
The unit labor cost shows the human labor cost required in the production of a product, whether that product is a material product or a service.
Some amount of human labor is required to produce a product or to provide a service. As a general rule, people who participate in the production and delivery of goods and services do this in exchange for compensation in the form of returns or salaries. Workers are also required to pay taxes and social security contributions to government agencies. Salaries social security contributions together make up total labor costs. Dividing labor costs between the number of goods produced by that labor reveals the unit labor cost.
It is possible to calculate the unit labor cost of just one company. However, unit labor cost indicators are most commonly used to track entire economies. This is accomplished by dividing a country’s average labor costs – including salaries, taxes and social security contributions – by its gross domestic product (GDP).
Unit labor costs show how competitive an economy is in relation to other economies. The rule is that the lower an economy’s unit labor cost is, the more competitive that economy is because lower production costs mean products can be sold for less.
There are three primary factors which result in low labor costs: low salaries, low taxes and social security contributions, and high productivity.
Low salaries are a key determining factor in developing countries. Low salaries result in low unit labor costs, and give these economies an advantage. For example, low salaries played a key role in China’s impressive economic growth over the past decades. Salaries in developed countries are high in relation to those in developing countries. This is particularly true in Switzerland. High salaries adversely affect unit labor costs.
However, taxes and social security contributions in Switzerland are low compare to those of many other economies, which positively influences unit labor costs. Increasing taxes and social contributions in countries like France and Italy have played a significant role in the increase of unit labor costs in those countries.
Productivity is the third deciding factor. Productivity measures the number of units of goods and services which are produced per worker. The higher the number of units produced per worker in a company or economy within a given time frame, the higher the productivity of each worker is and the lower the unit labor cost is. There is a direct link between salaries and productivity. Skilled workers are generally very productive, and therefore expect to be paid high salaries. The high proportion of skilled workers in Switzerland is one reason why Switzerland has maintained a competitive unit labor cost in spite of high salaries.
Salary increases do not necessarily adversely affect unit labor costs. They can be balanced by reductions of taxes or social security contributions by governments or by the implementation of more efficient practices or labor-replacing technologies by companies.
If salaries increase (to balance the effects of inflation, for example) but productivity does not increase at the same pace, unit labor costs increase. This results in the corresponding economy becoming less competitive.