Increasing labor costs in CSE as a chance for the future growth

Budapest, Hungary (Maria Bninska, Public domain)

According to the latest Eurostat data, hourly labor costs rose by 2.5 per cent in the Eurozone and by 2.7 per cent in the EU28 in the Q3’18 y/y. The corresponding numbers for the Q2’18 were 2.3 per cent and 2.7 per cent respectively.

Eurostat measures two main components of labor costs: wages&salaries and non-wage costs. In the Eurozone, the first of the two values grew by 2.4 per cent and the second by 3 per cent. In the EU28, the costs of hourly wages&salaries rose by 2.7 per cent and non-wage component rose by 2.4 per cent.

Unsurprisingly, the results for the Q3’18 show great disparities between the old and the new members of the European Union. While the increase in nominal hourly labor costs in the EU’s southern and western member states did not exceed 3 per cent, the growth in CSE countries did not go below 6 per cent.

The highest annual increases in hourly labor costs for the whole economy were registered in Romania (+13.9 per cent), Latvia (+13.2 per cent) and Lithuania (+10.7 per cent), while the lowest annual increases in hourly labor costs were recorded in Belgium (+1.2 per cent), Portugal (+1.5 per cent), Malta and Finland (both at +1.6 per cent).

The lowest growth in hourly labor costs among CSE EU member states was recorded in Poland. With a 6.7 per cent increase, Polish labor costs still grew at more than a double the rate of the fastest grower among the older EU members, Spain.

Lacking labor force

The growing divergence between the Western and Eastern part of the EU in terms of labor costs increases is a direct result of another long-term problem — labor shortages in the CSE countries resulting from economic migration and demographic factors.

According to another Eurostat data, around 3 million people moved from one of the Visegrad countries to Western Europe between 2004 and 2016. Moreover, statistics show that the Visegrad Four’s population could shrink by another 6.5 million people by 2060.

The situation is even more dire further east, particularly in the Baltic states, Romania and Bulgaria. According to the UN’s Department of Economic and Social Affairs, nine of the world’s countries most at risk of losing citizens over the next few decades are former communist nations. Countries such as Latvia, which had lost over 25 per cent of its residents since the collapse of the Soviet Union in 1991, are particularly vulnerable to depopulation. The United Nations predicts that by 2050, Latvia might have lost an additional 22 per cent of its current population.

According to international recruiter ManpowerGroup, Romania and Bulgaria are some of the greatest sufferers from the global talent shortage. In Romania, more than four out of five employers are having troubles finding employees with skills required for positions needed to be filled. According to the group’s report, 81 per cent of employers surveyed admitted that they were struggling with finding the right people.

Bulgaria is another country in the region suffering from a shrinking work force. According to the group’s survey, 68 per cent of employers in this Balkan country said they had difficulty filling positions.

Obstacle to growth or an opportunity?

The growing costs of labor across CSE, driven by the lack of workers, represents a major challenge to the CSE’s growth model. Ever since the transition to a market economy nearly three decades ago, the regional governments have been taking advantage of their skilled and relatively low-cost working force to attract foreign investment.

According to the latest McKinsey report “The rise of digital challengers”, this developmental strategy has helped CSE countries to bring about “a golden age of growth”, making the region one of the most attractive places to invest in. “The ten CSE countries examined in this report — Bulgaria, Croatia, the Czech Republic, Hungary, Latvia, Lithuania, Poland, Romania, Slovakia, and Slovenia — recorded on average a 114 per cent increase in GDP per capita between 1996 and 2017,” the McKinsey experts wrote.

According to McKinsey, the factors that have been driving the growth in the region: traditional industries, dynamic exports, investments from abroad, labor-cost advantages and EU funding, have reached their limits. “Workforce costs are rising and there are limited labor reserves left to plug into the economy, with unemployment at record low levels — on average 6.5 per cent in 2017, compared to 7.6 per cent in the EU. But labor productivity still lags behind Western Europe. And on top of it, the inflow of EU funds to CSE countries is likely to slow down after 2020,” authors of the report warned.

 “Essentially, the CSE countries have two options: either they continue with the old model of economic development, or they use the momentum to shift gears and transfer the economy to a more advanced stage,” McKinsey stressed in its report. “Today, CSE has the chance to make a strategic choice that will determine its growth path for decades to come. Our analysis shows that developing the region’s digital economy across all sectors would bring significant economic benefits, primarily due to the resulting productivity gains.”

Digitization of the economies in the region is seen as the main alternative to the old economic model. “By closing the digital gap to Western and Northern Europe, CSE could earn up to EUR200bn in additional GDP by 2025 — a gain almost the size of Portugal’s entire economy in 2017. In this aspirational scenario, the region’s digital economy would grow to represent 16 per cent of GDP by 2025,” McKinsey wrote.  

Further digitization of CEE economies would improve the region’s productivity through an economic transformation of both the public and private sectors. The authors of the report argue that CSE countries are uniquely positioned to take advantage of the drive towards digital economy.

The only alternative to embracing the digital economy is “business as usual” scenario, whereby CSE economies maintain their historical growth rate, “expanding by just EUR60bn and representing 8.7 per cent of GDP in 2015. By doing so, the authors of the report conclude, “CSE countries would miss out on the additional one percentage point of annual GDP growth and remain long way from the ‘digital frontier’ represented by the countries of Northern Europe.”

Filip Brokeš is an analyst and a journalist specializing in international relations.

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