For faster wage growth in central and eastern Europe

By Martin Myant
There are huge disparities in wage levels across the EU. As Figure 1 shows, the level in Romania in 2015 was about half that of Czechia which was in turn less than one third the German level, with the gap actually increasing since 2008. Some differences in pay reflect different kinds of work, but gaps remain enormous even where work tasks are very similar. This applies to many familiar jobs, such as teachers, bus drivers, bar staff or car-assembly workers, many of whom can easily move between countries. It is not credible to suggest that German bus drivers transport six times as many passengers, or German teachers instruct six times as many students as their Romanian colleagues.

The European Commission and others have argued that such low pay levels are essential for maintaining international competitiveness, a term given apparent numerical precision in the measure of ‘unit labour costs’ (ULC), the labour cost of producing one unit of national income. They warn that even a small increase in wages without a matching increase in productivity will lead to lower exports, GDP and employment.

However, changes in ULC are a poor measure of export competitiveness. They are derived from productivity measured across the whole economy, even though many activities – including most obviously public services – do not affect international trade. It would therefore seem better to use export prices or labour costs in exporting sectors. Yet even these, like ULC, prove to be a poor measure of competitiveness for traded goods in economies heavily dependent on outsourcing and inward investment by multinational companies and with wages far below the western European level. Nonetheless, the European Commission sticks with ULC, and that is the measure we are considering here.

The root of the problem lies in the way productivity is measured and compared between countries. In public services, such as education and health, the measure of output is derived from input costs, meaning, to a great extent, pay levels. Productivity therefore appears low simply because wages are low, without any reference to the content of the work. The outcome can be similar even in manufacturing industry. Firms outsource because wages are lower for making the same products. That is then reflected in lower prices and hence in lower measured productivity. Thus, workers producing a car component outsourced to Czechia appear to be less productive than their German colleagues because the product is being sold at a lower price than when it was made in Germany.

Škoda in Czechia, part of the Volkswagen group, pays its employees around a third of the German level. The difference does not indicate lower productivity in terms of cars produced. It is reflected in somewhat higher profits in the Czech plants, in the decision to locate production of cheaper models in those plants, and probably also in the low transfer prices of components (notably engines and gearboxes) made in Czechia for other parts of the Volkswagen group. If pay were higher for workers producing Volkswagen engines in the Škoda plant, prices would be higher and productivity of Czech workers would be measured as closer to that of German workers making the same product.

Past experience proves that rising ULC do not prevent rising exports. Figure 2 demonstrates this for Czechia. Until 2008, ULC were moving steadily upwards due to a rising exchange rate and wage increases, in both public and private sectors. These then stopped in the post-crisis period. Exports faltered during the economic crisis before resuming much the same growth rate as before. It was evidently just as worthwhile for multinational companies to increase production in Czechia, whether or not wages increased, when they remained so much lower than in western Europe.

There is scope for wages in CEE countries to draw closer to western European levels. That could be done by resuming currency revaluation for those countries outside the Eurozone, by negotiating higher wages through collective bargaining and by increasing minimum wages. Much higher wages might eventually lead multinational companies to relocate elsewhere, but that would currently be difficult, costly and pointless. Labour accounts for only about 6% of Škoda’s total costs, while the costs of moving would be enormous. Meanwhile, higher wages would help stem the outflow of skilled and qualified workers necessary for the activities – research, development and innovation – that support higher pay levels in western Europe. Higher pay would thereby allow for inward investment and domestic economic activity at a higher technological level.

Martin Meant is Senior Researcher and Head of Unit European Economic, Employment and Social Policy at the European Trade Union Institute (ETUI) in Brussels.

This article was first published in LSE European politics and policy http://blogs.lse.ac.uk/europpblog/2017/02/14/pay-rise-eastern-europe/