Growing demand and growth in productivity are a bit like a horse and carriage. You can’t have one without the other. At least you need both, if you want sustainable economic growth.

In an ideal world, over time we want to produce more output for every hour we work, and we want our hourly pay to go up in proportion to our extra productivity. Multiply that across the economy and we get more output, and more demand to meet the extra supply.

In the UK, we have a double problem. Wages are not going up with inflation. In fact in the three months to December average pay including bonuses rose by just 1.4 per cent. Annual inflation back in December was 2.7 per cent. So once again, average workers were worse off during the period in question. If you compare wage growth with inflation as measured by the RPI index, the picture looks even worse. Inflation by this index was 3.1 per cent in December, and has, in fact, been greater than wage inflation every month since March 2010.

But that is just half of the UK’s problem. The other half relates to productivity. That too has been awful. According to the ONS, output per hour in the UK is 21 percentage points below the average for the G7. Look at the big picture. The UK economy is either in recession or very close, yet employment is rising. How can that be? Answer: because productivity is declining.

In other words, in the UK we have the precise opposite of the ideal world. We have falling wages and falling productivity. Sure employment is at a record high, unemployment at 7.8 per cent is surprisingly high considering where we are with the economy, and yet the price we seem to be paying for jobs is a declining economy.

In the troubled regions of the Eurozone, the problems at face value are quite different. But perhaps the end result is very similar. The story for the Eurozone takes a slightly different view. The focus this time is on unit labour costs. That is to say the cost of labour for every unit produced.

First let’s look at some history. From the moment the Euro was launched to the point when things went pear shaped in 2008/09 the so called peripheral economies – that’s Portugal, Ireland, Italy, Greece and Spain – saw their growth in unit labour costs race ahead of the growth seen in France, and even more so relative to Germany.

Since 2009/09 the gap has closed. In fact with Ireland and Portugal, the gap with France has closed and gone into reverse, so much that growth in unit labour costs in Ireland and Portugal since 1999 is now lower than the equivalent for France. Spain is not far behind. Greece has a bit more work to do. Look at the figures and official data indicates that since 2008/09 unit labour costs have fallen by 14.7 per cent in Greece, 14.1 per cent in Ireland, 7.6 per cent in Spain, and 2.4 per cent in Portugal. They have risen 1.1 per cent in Italy, however. There are doubts over the accuracy of this official data, but you get the point. The gap has been closing.

The markets are chuffed. They see falling unit labour costs in these countries as evidence that the slow march to recovery is well on its way.

But is that right? As you know, unemployment in these countries is much higher than in the UK, and indeed in Greece and Spain – where more than a quarter of the working population is out of work – this is a level one can only call terrifying.

Sure unit labour costs are falling, but given the massive level of unemployment, is that surprising?

The Eurozone really needs exactly the same development we require in the UK: rising productivity and rising wages. Perhaps, because of their lack of competiveness with Germany, and because – unlike the UK – they are not tied into a fixed exchange rate with Germany, they need productivity growth to slightly exceed wage growth.

This is just not happening.

The markets may love the data, but just like a bad marriage, when truth dawns, things may unravel badly.

© Investment & Business News 2013