Wages and labour costs developments in the EU and its Member States
Drivers of and scope for sustainable wage growth
The challenges related to the decline in purchasing power, as identified above, raise the question of whether there is leeway for further increasing wages in a sustainable way.
This section analyses the factors that may affect the room for wage increases at the EU level (Section 2.4.1) and the differences across Member States and sectors (Section 2.4.2).
Conflicting factors determine the leeway for further wage growth
Over the last decade, wage growth has been lower than predicted on the basis of its main macroeconomic drivers in many Member States, but this is likely to change in 2024.
The growth of nominal compensation per employee can be compared with a ‘benchmark’ growth rate predicted by developments in macroeconomic drivers. This helps assess current wage dynamics, despite its backward-looking character. This year, a number of revisions have been introduced to the baseline wage benchmark methodology to improve its performance and time coverage (see Box 2.3). Cumulated over 2014 to 2022, wage growth was below its benchmark in about half of the Member States, most notably in Greece, Croatia and Poland (Graph2.10). Instead, wage growth was well above the benchmark in Bulgaria, Estonia, Latvia, Lithuania and Romania. In 2023, the rebound in real wages started and wage growth is forecast to exceed wage benchmarks in most Member States in 2024 (Section 2.2). In some of them, the cumulated gap over the past decade remains negative suggesting that there may be a possible room for further wage growth. However, additional indicators, including inflation expectations, unit labour cost (ULC) developments and unit profits can shed further light on the scope for wage increases, as argued below.
Graph 2.10: Gap in wage growth relative to its benchmark (%)
Note:
Wage benchmarks are predicted by developments in inflation, productivity, the trade balance and the unemployment rate. The cumulative gaps for Romania and Bulgaria for 2014–2022 are 42 % and 58 %, respectively. These two results have been given as simple digits in the figure to allow a narrower range on the vertical axis and hence improve the readability of the graph.
Source:
Own calculations based on AMECO [1100 OVGD; 1000 NETD; 3099427 XUNRQ; 1000 ZCPIH; 1000 ZUTN; 1000 UWCD; 1000 NWTD] and Eurostat [ert_eff_ic_a; une_rt_a_h]).
Box 2.3: Predicting wage developments based on macroeconomic fundamentals – a revised methodology
The methodology of the European Commission to estimate wage benchmarks is carried out in two steps (European Commission: Directorate-General for Employment, Social Affairs and Inclusion, 2022). In the framework of error correction models, wage levels are first regressed on the levels of prices and productivity as well as unemployment to account for the long-term relationship between wage levels and their drivers. In a second step, wage growth is regressed on the short-term deviations of its main drivers and on a term that represents the deviation of the actual wage level from its predicted level in the first step. The predictions are based on a panel regression of EU Member States estimated on the basis of yearly data between 2000 and 2019. The approach allows to assess if wage growth is broadly in line with the equilibrium in the domestic labour market, which differs from an alternative benchmark that compares the actual wage growth with what would have guaranteed stable price competitiveness .
The estimated wage benchmarks presented in this chapter are based on a recently updated methodology (European Commission: Directorate-General for Employment, Social Affairs and Inclusion, 2024e). While the general approach remains the same, the revisions aim at better reflecting the following aspects:
- Differentiating regression estimates by country groups allows to better account for some structural features such as the Balassa-Samuelson effect for catching-up countries. Wage and competitiveness developments have evolved quite differently across country groups, in particular western, southern and central and eastern European countries. For instance, some southern European witnessed moderate wage growth and competitiveness gains in countries, whereas some central and eastern European countries showed dynamic wage developments and increasing competitiveness concerns. Introducing region-specific dummy variables and interacting them with the main explanatory variables allows for differences in slope estimates for the explanatory variables across country groups.
- External balances may provide additional information on competitiveness, that is relevant to explaining wage developments. In particular, the trade balance may provide additional information about cost- and non-cost competitiveness aspects, not covered by productivity, inflation and labour market tightness. For instance, exports can have a positive effect on industry wage premium (Du Caju et al., 2011).
- Adding lags of dependent variables can better account for the delayed response of wages to its main drivers. The effect of macroeconomic variables, such as productivity, inflation and unemployment, are likely to affect wages with a delay. Therefore, the main explanatory variables are introduced as contemporaneous variables and with a lag of 1 year.
- Data are taken into account until 2023. In previous rounds of updating the Commission’s wage benchmarks, the sample was restricted to the period from 2000 to 2019. Extending the sample to 2023 allows to increase the number of observations and account for the patterns witnessed during the COVID-19 pandemic and the energy crisis in 2022.
Compared with the previous methodology, the model better explains actual wage developments and more accurately accounts for country specificities. The revised methodology reduces the that accumulated since 2012 for almost all Member States, including those with sizeable positive gaps (such as the Baltic countries, Bulgaria, Luxembourg and Romania) and negative gaps (including a number of southern European countries, Belgium and Ireland). Compared with the previous methodology, the negative gaps for 2022 also become smaller in many cases. This notably suggests that the revised model better captures the differentiated effects of high inflation on wages across countries. Overall, the explanatory power of the model, as measured by the R-squared statistics, improves despite the fluctuation introduced by extending the sample until 2023.
- Related note aFor example consistent with stable export market shares or with a constant value of the Real Effective Exchange Rate computed on the basis of ULCs.
So far, wage dynamics have not exacerbated inflationary pressures.
In theory, high wage growth could have some impact on inflation in the short term, as businesses may adjust prices to cover part of the recent pay rises. This risk of wages triggering inflation mainly stems from a possible de-anchoring of inflation expectations . However, inflation expectations over the next 2–4 years remain broadly stable, between 1.9 % and 2.2 % (Graph 2.11a), while wage growth is set to decrease (Section 2.2). This indicates a low risk of a wage-price spiral at this stage .
Graph 2.11: Inflation and ULCs
Note:
The survey covers the euro area. HICP = harmonised index of consumer prices; M3 = third month; ULC = unit labour cost.
Sources:
European Central Bank Survey of Professional Forecasters and Eurostat [prc_hicp_midx] [namq_10_a10], Ameco 1000UWCD,1000UWCD,1000NETD,1100OVGD].
High unit profits can, at least temporarily, act as a buffer and absorb inflationary pressure stemming from wages .
Corporate profits have increased substantially with the energy crisis, from 51.3 % in 2021 to 53.2 % of GDP in 2022. However, they started to decrease in 2023 and are forecast to continue decreasing in 2024, although remaining high. As real wages continue to rise, the decline in unit profits seems to have absorbed wage increases, thereby dampening inflationary effects. With unit profits still slightly above their 2019 level at 46.1 % in the second quarter of 2024, compared with 45.2 % in the fourth quarter of 2019, they could continue to play this mitigating role also in the near future, although this effect is likely to wane (Graph 2.12). At the country level, unit profits are comparatively high and increased recently in Greece, Ireland, Cyprus, Hungary, Malta, Poland, and Romania. Instead, they decreased, from a low level, in France and Luxembourg (Graph 2.13b).
Graph 2.12: Unit profits, year-on-year growth rate, EU-27
Note:
Unit profits are computed based on quarterly national accounts, defined as the difference between gross value added and compensation of employees divided by gross value added.
Source:
Eurostat [namq_10_a10].
In the medium and long term, higher productivity growth in the EU, also compared with other advanced economies, would be needed to widen the margin for wage increases.
ULCs, the ratio of nominal compensation to productivity that is commonly used as a measure of cost competitiveness , have increased at a similar pace in the EU, the United Kingdom and the United States (about 15-17 %) (Graph 2.11b). At the same time, both nominal wages and productivity increased less in the EU: productivity in the EU increased by only 0.7 % between 2019 and 2023, against 6.4 % in the United States and 1.4 % in the United Kingdom, whereas nominal compensation growth stood at 15.9 % in the EU between 2019 and 2023, compared with 20.5 % in the United States and 19.2 % in the United Kingdom. Therefore, strengthening productivity could yield further room to boost wages sustainably in the EU . Although labour productivity growth is forecast to accelerate in the EU, it is expected to remain structurally low at 0.9 % in 2025 .
Wage premium for green and digital skills point to a positive effect of productivity on wages but may also reflect skills shortages.
Both the green and digital transitions lead to innovation and the use of new technologies, which tends to raise productivity . This increase in output per worker can partly explain the wage premia of green jobs for advanced economies that is estimated to be between 4 % and 7 % . Similarly, jobs with a high digital intensity entail a 18 % wage premium in the EU on average, and above 25 % in the Baltic countries, Bulgaria and Cyprus . Several studies at the national level also point to a particularly high digital wage premiums in some sectors. However, these digital and green wage premiums may reflect not only productivity gains associated with the twin transition, but also skills shortages (see also Box 2.1). In fact, firms may compete for the limited number of high-skilled workers through the wages they offer .
In turn, higher wages may also incentivise upskilling and innovation, and thereby promote productivity.
The existence of wage premiums to reward certain skills can motivate employees to upskill and thereby become more productive. Moreover, increases in minimum wages were found to boost the labour productivity of low wage earners . Also at the level of firms, higher wages can push for more rapid technological change and innovation, and thus productivity, in order to preserve competitiveness. For instance, wage pressure can incentivise firms to improve their competitiveness by means of non-price aspects, such as the quality of their products or services, rather than by means of lower prices .
Some evidence points to room for sustainable wage increases in some countries
Moderate wage developments in some countries helped them improve their competitiveness as compared with more competitive exporters in the EU.
For instance, comparatively low wage and unit labour cost growth was registered in 2022 and 2023 in Greece, Spain, France, Italy, Cyprus and Malta (Graph 2.14). Some of these countries are also marked by weak net international investment positions but have gained export market shares in recent years (Graph 2.13a) . Moderate wage increases also sustained competitiveness in the Nordic countries, which are marked by high income levels, although Finland and Sweden have experienced some losses in export market shares. In contrast, some exporters with very strong net international investment positions, notably Germany and the Netherlands, have experienced slightly higher ULC growth and some losses in export market shares. Looking over a longer period, wage moderation in the last decade in many Member States that faced competitiveness gaps (notably in southern Europe) resulted in some rebalancing in cost competitiveness, in particular within the euro area. This has supported their cost competitiveness and helped them improve their external position over time.
Combining favourable cost competitiveness dynamics with higher productivity growth could generate additional room for sustainable wage growth in most southern Member States.
The favourable cost competitiveness developments in recent years are accompanied by high unit profits and moderate wage growth Spain, Greece, Italy, Cyprus and Malta (Graphs 2.13b; and Graph 2.14a). Portugal showed somewhat lower unit profits and more robust wage growth in 2022-2023, but its ULC growth has been moderate. This suggests that there is still some room for wage increases in these Member States, which could help address some remaining effects of the decline in incomes in 2022 and 2023 (Section 2.3). At the same time, boosting productivity growth is also key to providing room for higher sustainable wage growth in the medium to long term.
Graph 2.13: ULCs, export market shares and unit profits across countries
Note:
Unit labour costs are defined as the ratio of total labour compensation per employee to output per persons employed (labour productivity). The export market share is calculated by dividing the exports of the country by the total world exports. Unit profits are defined as the difference between gross value added and compensation of employees divided by gross value added.
Source:
AMECO [1.0.0.0.UWCD,1.0.0.0.NWTD,1.0.0.0.NETD,1.0.0.0.OVGD,1.0.0.0.UVGE], Eurostat [tipsex13__custom_11625252].
Graph 2.14: ULCs, wages and productivity across countries
Note:
ULCs are defined as the ratio of total labour compensation per employee to output per persons employed (labour productivity). Labour productivity growth is shown with a negative sign in the graph, in line with the definition of ULCs.
Source:
AMECO [1.0.0.0.UWCD,1.0.0.0.NWTD,1.0.0.0.NETD,1.0.0.0.OVGD].
By contrast, continued concerns about competitiveness in some Member States, including in central and eastern Europe, call for a cautious assessment of the room for wage increases.
The Baltic countries, Bulgaria, Croatia, Luxembourg, Hungary, Poland, and Romania experienced strong wage and ULC growth with the energy crisis. Moreover, Luxembourg, Hungary, Romania and Slovakia showed signs of weakening external positions and/or a loss in export market shares (Graph 2.13a, and Graph 2.14). Although in the case of central and eastern European Member States this may partly reflect a welcome catching-up process in line with the Samuelson-Balassa theory, concerns have grown about deteriorating cost competitiveness for Bulgaria, Czechia, Estonia, Croatia, Latvia, Lithuania, Hungary, Poland, Romania, and Slovakia . Further efforts to increase productivity growth represent a sustainable way towards further real wage growth which could help to address remaining social challenges.