Photographer: Martin Divisek/Bloomberg

East EU’s Cheap-Labor Growth Model at Risk as Wages Keep Rising

Wage growth above productivity risks eroding competitiveness
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Central and eastern Europe has long been considered a relatively cheap manufacturing hub to make sophisticated products like cars and electronics goods at a fraction of what it would cost in the West. Accelerating salary growth may now be changing that perception.

Average nominal wages rose 10.7 percent in Hungary in February from a year ago, the most in nine years, the nation’s statistics office said Thursday. The release followed a surprise 5.2 percent increase in Polish wages reported a day earlier, the highest reading since June, and mirrors recent development across the region.

While the ex-communist European Union members have been growing faster than euro-area economies and unemployment in many countries approached record lows, salaries have for years been slow to catch up. But now intensifying demands for higher pay risks eroding the region’s growth model based on cheap labor that helped attract capital from abroad, including factories operated by car makers Volkswagen AG and Kia Motors Corp as well as other industrial giants like General Electric Co.

“Wage growth in the region has started to pick up, fueled by a combination of labor shortages and government policies,” said William Jackson, an economist at Capital Economics Ltd. in London. “The key point is that real wage growth is outstripping productivity growth. The upshot is that rising wages will be starting to erode firms’ profit margins.”

Governments in the region are also supporting calls for higher salaries, often targeting multinational corporations. Czech Premier Bohuslav Sobotka has made the end of cheap labor one of the key themes in his Social Democrats’ campaign before October elections. His Slovak counterpart, Robert Fico, recently asked why a worker in a Volkswagen factory in the former communist country makes only a third of that of his German peer for the same work.

Rising wages may not be an imminent threat to the region’s competitiveness, but the development may backfire by fueling inflation, Capital Economics’ Jackson said. “The region still looks competitive,” Jackson said. “But if things continue in this way, it could ultimately lead to a buildup of imbalances and perhaps an adjustment in currencies further down the lines.”

--With assistance from Zoltan Simon, Dorota Bartyzel and Andra Timu.

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