Wage hikes in Eastern European countries undermine their attractiveness

Eastern European countries are experiencing competitiveness problems and the foreign direct investment they enjoy may suffer as a result. In a recent study, Eric Dor, director of economic research at the IESEG School of Management, notes that labor cost increases in Eastern European countries "have been much higher than in the euro area since 2015." Between the first quarter of 2015 and the second quarter of 2023, this growth was 16% in the eurozone. It was 67% in Bulgaria, 62% in Romania, 52% in Hungary, 41% in the Czech Republic and 40% in Poland.

If we exclude the impact of exchange rates in these countries, which have their own currencies, measurements in euros give a similar picture. Over the same period, labor costs measured in euros rose by 67% in Bulgaria, 62% in the Czech Republic, 46% in Romania, 25% in Poland and 19% in Hungary.

The relative attractiveness of these countries has declined, even though their labor costs are still significantly lower than in the rest of the European Union," warns Eric Dor.

One of the reasons for the loss of competitiveness is related to the dynamics of wages in these countries, says the IESEG study. The International Monetary Fund (IMF) also draws attention to this in its latest report on the economic outlook for Central, Eastern and Southeastern Europe (Cesee). The multilateral institution notes that wages in this region have grown more strongly than in Western Europe. In the latter, wage growth started to accelerate in 2021 and reached 5% by mid-2023, compared to 1-3% between 2015 and 2019. For Eastern Europe, the figures are more than 10% and between 5% and 8% respectively.

When the impact of inflation is taken into account, all European countries have seen a decline in the wages actually received (real wages). "The erosion of purchasing power has been significant across Europe, but especially in advanced European economies," emphasizes the Foundation. In Western Europe, real wages have fallen by 8% since Q4 2020. In the Cesi countries, the figure was only 5%.

Eastern Europe suffers from its dependence on Germany and hydrocarbons

To explain this difference, the Fund's economists put forward the idea that wage demands in the latter countries are based more on pre-negotiation inflation rates rather than on expectations of rising prices, as would be the case in the West. Because Eastern European countries have higher inflation than the West, they raise nominal wages more sharply, which reduces their competitiveness, the IMF summarizes.

This trend will continue: on average, wages in advanced European countries are expected to rise by 5 and 4.5 percent in 2023 and 2024. For Central and Eastern European countries, this growth will amount to 9% and 7%. For Eric Dore, the loss of competitiveness could lead to lower exports and higher imports, ultimately worsening his trade balance. "So far, mainly in Romania, the trade balance in goods excluding energy has continued to deteriorate since 2015, with the deficit worsening," the economist points out.