European School of Management Italia (C) Copyright 2004

European School of Management Italia (C) Copyright 2004
Economic Aspects of Wage Negotiation Dr Gustavo Rinaldi ITC ILO Consultant (University of Turin, ESCP –Europe) 1 1

The accountant's profit and loss account
European School of Management Italia (C) Copyright 2004 The accountant's profit and loss account +Revenues (price X quantity)‏ - cost of raw materials, labour, suppliers - depreciation = OPERATING PROFIT - interest = PRE TAX PROFIT Tax = AFTER TAX PROFIT - dividends = RETAINED EARNINGS

Inflation

Standard of Life Depends on the ability of people in acquiring goods. Depends on how much they earn. Depends on how much goods are expensive.

Standard of Life It can be measured by the real income.
. Income = Real Income Level of Prices

Standard of Life Level of Prices
. Income = Real Income Level of Prices The real income indicates the purchasing power of the recipient of that income. It indicates how many goods she/he can acquire.

Level of Prices We measure it by observing the total price of a set (basket) of goods. We usually compare the price of the basket of goods today with the price of that basket of goods at a different date. The ratio between the two prices gives an index.

Price Index Today Price of a set of goods at the reference time
Price of a set of goods today Price of a set of goods at the reference time Sometimes they are multiplied by 100.

Price Index: P t+1 P t

Consumer Price Index - CPI
European School of Management Italia (C) Copyright 2004 Consumer Price Index - CPI It is about what we consume. Ii is based on a basket of goods made either domestically or abroad. Different goods are included in the basket with different weights. It is usually defined by the statistical authority of the country. Politics plays a role. Usually available every month.

Politics in the CPI Sometimes governments like to underestimate the inflation in their country. This can be done with different techniques. They can exclude or under represent some goods. They can over-represent the weight of certain goods. Technology goods have prices which increase slowly or sometimes decrease.

GDP Deflator It is about what we produce domestically. It is based on a basket of goods made domestically. In our country we may produce goods that we do not consume and we may consume foreign goods. Different goods are included in the basket with weights corresponding to their share in the national GDP. Available every 3 months. It is a measure of the competitiveness of a country.

Nominal GDP The sum of final goods produced in the country at current prices.

Real GDP = GDP Constant prices GDP In terms of goods Quantities of this year, prices of a different year (the reference year).

GDP Deflator: Nominal GDP Real GDP

GDP Deflator

GDP Deflator steepness = growth rate

GDP Deflator

BIH (GDP Deflator) and BIHC (Consumer Price Index)

CHN (GDP Deflator) and CHNC (Consumer Price Index)

Other Price Indexes exist
European School of Management Italia (C) Copyright 2004 Other Price Indexes exist They may not include some goods. They may exclude certain goods on purpose. Sometimes they are the result of a political agreement, e.g. Planned Price Index In Italy for many years workers recovered the planned inflation not the actual one.

Inflation It is a generalized increase of prices. Some inflation is natural and necessary. Too much is a problem. It redistributes income from those with fixed income to those with adjusted income. It takes money from creditors and it gives them to debtors.

Rate: A ratio between two measurements Very often it is the ratio between a difference and a reference value

Rate of variation x = a variabie (e.g. GDP, Consumption, Investments, etc.)‏ This variable at time t This variable at time t+1

Rate of variation The variation of x between t and t+1

The variation rate

An Index H is some variable A ratio between two variables or between two different values of the same variable H

An Index of variation

GDP Deflator Pt = Nominal GDP Real GDP € Yt Pt = Yt

Inflation Rate  P P t Inflation rate = (Price Index - 1)

Inflation Decreasing inflation Disinflation Deflation

Productivity

Productivity (average) A measure of efficiency The ability of transforming input into output Productivity = Output Input 35 35

Average Labor Productivity A measure of Efficiency of Labor (or of the company?) Productivity = Output . Units of Labor 36 36

Units of Labour Heads an easy measure, but what if workers are kept with reduced working hours? Worked Hours more difficult to find, but more precise. 37 37

Measures of Output Physical units. Monetary terms Total sales Value Added 38 38

Physical Measures of Output They are not affected by prices. They seem objective. Problems arise when different workers produce different goods, e.g. different type of cars or different cloths. We may actually end up comparing totally different things. 39 39

One Car

Monetary Measures of Output They are affected by prices. They take into account the value of goods. Prices may be an indicator of quality. Prices may be an effect of good management. Prices may also be an indicator of monopolistic power of the firm. 42 42

Monetary Measures of Output Sales are easy to find and to calculate. Sales do not only represent the effects of work but also of other inputs, e.g. expensive components. Value Added is probably a more precise measurement. Gross Value Added = (Sales – Intermediate Consumption) 43 43

Intermediate consumption:
European School of Management Italia (C) Copyright 2004 Intermediate consumption: Things and services that the firm buys from external sources (do not include those goods which do not disappear during production, i.e. equipment, durable production goods).

Intermediate consumption:
European School of Management Italia (C) Copyright 2004 Intermediate consumption: approximately corresponds to the value of the sum of all the received invoices.(does not include those goods which do not disappear during production, i.e. equipment, durable production goods, patents,).

Intermediate consumption includes:
European School of Management Italia (C) Copyright 2004 Intermediate consumption includes: raw materials partly finished goods sub-assemblies services you buy outside Banking costs Services of outsourcees.

Intermediate consumption does not include:
European School of Management Italia (C) Copyright 2004 Intermediate consumption does not include: Equipment Real estate Intangible Assets Wages to employees Compensation of equity Indirect taxes Interests Rents to families

Value Added: represents the contribution of labour and capital to the production process. Gross value added = + Gross output intermediate consumption Net value added = gross value added - consumption of fixed capital (or depreciation charges) Net value added = gross wages + pre-tax profits net of depreciation + indirect taxes - subsidies. + Interests + Rents to families

Marginal Productivity The output created by an additional worker or by an additional investment. It is used to explain differences in wages. It is used in more sophisticated analyses. It is easy to measure with simple technologies, but not with complex technologies. 49 49

What about the other production factor?
European School of Management Italia (C) Copyright 2004 What about the other production factor?

Does Gross Value Added really and only represent the work of employees? No. It also depends on the invested capital and on management. Workers may have low productivity because the equipment is very old or because the company is not well managed. And vice-versa. 51 51

Production depends on:
Labour Invested Capital Type of raw materials and components. Management

The productivity of one factor depends on the others
Good investments make labour more productive. Bad or little capital may heavily affect labour productivity. Good management and good marketing may improve the sale price of the product. Sometimes international conditions affect the price of the product.

Profitability

If you need to attract capital, capital must receive some compensation
This is measured in different ways.

Some Measures of Profitability
Net Profit Margin EBITDA Margin Operating Profit Margin Return on Equity Return on Assets

Net Profit Margin: Net Income/ Sales
Net Income = After Tax Net Profit

EBITDA MARGIN: EBITDA / Sales
EBITDA= earnings before interest, taxes, depreciation (and amortization)

Operating Profit MARGIN: Operating Profit / Sales
Operating Profit = Sales – Non Financial Costs

Return On Equity : Net Income/ Equity
Net Income = After Tax Net Profit

Return On Assets : Net Income/ Assets
Net Income = After Tax Net Profit Assets In some cases people calculate: (net income + interest) / Assets

Financial cost Companies may make money with their core activity and then have heavy financial costs. The cost of obtaining money. Equity is only compensated when there are profits. Loans must be paid back. The higher the interest on loans, the heavier the financial burden.

Financial cost If a company is financed by a lender of the same shareholder, interests will remain in the same group. If the lender is in a tax haven, it will pay low or no taxes.

Unit Labour Cost

Cost of labour in different countries 10 years ago

Is German labor too expensive?
European School of Management Italia (C) Copyright 2004 Is German labor too expensive?

Cost of input per unit of production: Unitary cost of input Average productivity of this input 67 67

Cost of input per unit of production: In the case of Labor Unit Labor Cost = w = wage Q/L average productivity of L 68 68

Cost of input per unit of production: In the case of Labor Unit Labor Cost = wL = Wage Bill Q Production Production may be expressed in physical or monetary terms. 69 69

The role of Public Authority
It provides the respect of the law and the certainty of rules. It regulates (e.g. the utilities) and eventually subsidizes the private sector. It provides some services that the private sector either could not produce (e.g. police, defense, justice) or would not produce in the right quantity (e.g. education and health). Purchases goods and services. Redistributes income with taxes, social contributions and transfers to people. It regulates business cycles.

In our income statement we can also observe:
The tax rate. The level of social contribution. The price of utilities.

Outside the income statement:
The certainty of law. The quality of public services. The quality of regulation. The size and the management of public procurement. The good management of the whole economy.

Wages: Do not depend only on economic considerations. Economics matters. The End

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