Soaring wage growth risks blunting eastern Europe’s edge, IMF warns

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The IMF has warned rapid wage increases in central and eastern Europe risk eroding the region’s competitive edge.

Incomes have risen at double-digit levels in many countries in the region recent years, but the fund says productivity has largely stalled.

Alfred Kammer, head of the European department of the IMF, told the Financial Times the trend “could create a competitiveness problem” for a region that has benefited from western European companies relocating production there.

Kammer said that while high wage increases had long been the norm in the region, those seen in recent years were “of a different calibre”.

“Our warning is don’t get complacent and think this is due to a productivity increase,” he said ahead of the publication of the IMF’s annual report on Europe’s economic outlook. “It isn’t.”

Wages rose at double-digit annual rates in much of central and eastern Europe in the second quarter — from 16.9 per cent in Hungary to 9.9 per cent in Slovakia, with the region topping the EU tables for pay rises and outstripping the bloc’s 4.5 per cent average. However, inflation in much of the region has also far exceeded the EU average.

Wages are expected to grow at a weighted average of 11 per cent for 2023 as a whole, slowing to 7 per cent next year and 6 per cent in 2025, according to the IMF outlook.

The report is expected to put the fund on a collision course with eastern European governments, which have long targeted higher wages as one of the big benefits of EU membership.

Up until now, those gains for the region’s workers have been matched by improvements in productivity, with the competitiveness of the region’s workforce helping to attract vast sums of foreign direct investment, epitomised by western European carmakers opening new factories there.

But some countries, including Romania or Poland, have had millions of workers flock west, leading to tightness in the labour market — and creating fertile ground for those remaining to ask for bumper pay rises.

The IMF said the region’s governments should reduce budget deficits and implement measures to improve “worker relocation”, increase labour force participation and boost productivity.

Far from slowing down the trend, the incoming coalition government in Poland headed by Donald Tusk is expected to raise wages further in response to strong pressure from trade unions, which argue high inflation has hit their members hard.

Thousands of public workers demonstrated in Warsaw in September to demand such salary increases. Tusk and his partners have pledged to increase public sector wages by 20 per cent across the board.

The IMF said a “soft landing” was expected for most of the European economy, with inflation falling steadily and growth set to make a modest rebound from 1.3 per cent this year to 1.5 per cent next year.

But Kammer warned central banks against cutting interest rates too early, which could “reignite” inflation, leading to an even more painful series of rate rises to damp it down again.

The European Central Bank last month kept its policy rates unchanged for the first time in 15 months, but some central banks in countries that are not in the eurozone have started to cut rates recently, including those in Poland and Hungary.

Kammer said: “Rates need to stay high at close to these levels for a considerable time for many of the central banks throughout 2024 in order to achieve their inflation targets in 2025.”

Inflation in advanced Europe would fall from 5.8 per cent this year to 3.3 per cent next year, the IMF forecast, adding that inflation in European emerging market economies would drop from 11.9 per cent this year to 5.8 per cent next year.

Additional reporting by Marton Dunai in Budapest and Raphael Minder in Warsaw