Central Europe's unbalanced pay scales

By bne IntelliNews April 22, 2008

Mike Collier, Matt Day, Robert Smyth and Dominic Swire -

Salaries in Central Europe are fast converging with those in the richer West, but the rapid pace of this catch-up is uneven and causing growing inequality within the borders of these countries rather than between national borders. Analysts say it's still possible to take advantage of the wage gap between east and west, but it's becoming more difficult to identify where exactly to locate businesses.

Just as lots of Central Europeans have migrated west in search of a better standard of living, western companies have gone east looking for fatter profits. Trouble is, their arrival has sent wages skyrocketing and worse, the first to arrive vacuum up much of the talent. Late arrivals are being faced with growing labour shortages regardless of how much they are willing to pay. And given this phenomenon has been largely confined to the capital cities and most desirable parts of the countries, the hinterlands are depressed with few, badly paid jobs.

The regional differences in wages were already there before the fall of the communist regimes. Central planners tended to put specific industries, in particular heavy industries, in specific regions, with locations chosen for political rather than economic reasons. All the transition to market economies did was exacerbate these differences.

A survey published by the Organisation for Economic Co-operation and Development (OECD) in 2001 found that a coefficient measuring the variation of per capita GDP between the regions of several Central European OECD members rose between 1995 and 1997: the Czech Republic from 31 to 33, Hungary from 31 to 36 and Poland from 19 to 24.

This meant in practice that the Czech Republic's northwestern and southeastern regions became more deprived, while the areas around the two main cities of Prague and Plsen became better off. In Hungary, only the region around the capital Budapest withstood the fall in real GDP and rising unemployment. For Poland, a clear division opened up between the richer western and poorer eastern part. And this trend has got worse as foreign investment flooded in since 2001.

Bitty Baltic boom

The Baltic states were first out of the gate following the collapse of the Soviet Union in 1991 and enjoyed the bulk of the first wave of investment. Wages rose fast and are still rising: during 2007, average gross monthly wages rose by around 20% in both Estonia and Lithuania, and 30% in Latvia. However, rising wages are a mixed blessing as they feed inflation and create a labour force in a state of flux.

Away from the booming capitals (plus a sprinkling of medium-sized regional towns with established industrial bases such as Tartu, Ventspils and Klaipeda), wages remain pitifully low; despite their "Baltic Tiger" image, the Baltic hinterland contains some of Europe's poorest districts.

Unsurprisingly there is a "wage gradient" that runs from west to east across the Baltic region: the closer one gets to the EU's eastern border with Russia and Belarus (and the less "Baltic" the populations become), the poorer people are, as evidenced by tumbledown shacks, un-metalled roads and poor infrastructure. Counterintuitively, the gradient is not a straight line - in Lithuania the wages rise closer to the border. But as a rule of thumb throughout the Baltics, west is best and east is least as far as wages are concerned.

It's also worth noting that the levels of remuneration outlined below come from official statistics based on employees with a contract working within the tax system. Many of the lowest-paid members of the population supplement their income in the grey economy with cash-in-hand work or selling anything from mushrooms to firewood by the roadside.

In Estonia, Tallinn, the capital, led the way on wages with average monthly gross wages of €894. Harju county as a whole, which includes Tallinn, was only slightly lower on €882. At the other end of the scale is Valga county with monthly wages of €575. Though it's not one of the easternmost counties, it borders Latvia to the south and isn't helped by the fact the main road routes to Finland and Russia pass on either side of its borders. Of 15 counties in all, six record wages of less than EEK10,000 (€640) per month. Four of those are eastern counties and three have direct borders with Russia. The other two sub-10k counties are the western districts of Hiiu and Laane, largely protected national park areas dependent on fishing and tourism.

Latvia is formally divided into no fewer than 26 counties, but these can be grouped into four regions, roughly: Kurzeme in the west, Zemgale in the south, Latgale in the east and Vidzeme in the north (including the capital, Riga). Latgale is the poorest region, with average wages in December 2007 of a mere €471 per month. It is generally the case that the further you are from Riga, the less you can expect in your pay packet. While wages in Riga were a healthy €780, they drop to €658 in the area immediately around the capital. The furthermost regions of Vidzeme, in the far northeast of the country see levels of remuneration similar to the most deprived areas of southeastern Latgale.

The largest of the Baltic states, Lithuania, slightly bucks the trend of an eastwards drop-off in wages, for reasons that are largely geographical. Vilnius, the capital, is located in the extreme southeast of the country, and does not exert the same total dominance over the rest of the country as that done by Riga and Tallinn thanks to the presence of sizeable cities in Kaunas, Klaipeda, Panevezys and Siauliai. There's also the small matter of the Russian exclave of Kaliningrad eating into Lithuania, distorting natural trade routes along the Baltic coastline and effectively providing an "eastern" border - only in the west. Vilnius tops the list of Lithuania's 10 counties with average gross monthly earnings of €663. The two poorest counties, Taurage (€446) and Marijampole (€479) both border Kaliningrad. Apart from Vilnius, two other counties manage to top LTL2000 (€575) per month, both of them western: Klaipeda (€584) on the Baltic and its neighbour Telsiai (€583). Only slightly behind them is the centrally located second city of Kaunas on €564.

Blava bling

In Slovakia the average monthly wage in Bratislava is SKK26,910 (€833), that's a third higher than the same figures for the rest of the country (SKK17,893) and 40% more than in Presov, the region with the lowest wages in the country, averaging at just SKK16,253 per month, according to figures from the Statistical Office of the Slovak Republic. In neighbouring Austria, average wages in Vienna are only 10% higher than in the regions.

According to Juraj Barta, chief economist at Slovenska Sporitelna Bank, there are two main reasons behind the discrepancy of wages in Slovakia. Firstly, the high number of skilled workers in Bratislava compared with the regions means there are more higher paid jobs available. Secondly, the low level of unemployment, currently around 4%, is putting pressure on wage growth.

A further factor is that, as in many countries, the most interesting and challenging positions tend to be located in the capital, as Branislav Huncik, an expert in human resources at PricewaterhouseCoopers, discovered firsthand. Huncik was drawn to the bright lights of Bratislava from his hometown of Zilina close to the Polish border, because the kind of job he was after tends not to be offered in the smaller cities. "Theoretically, I could work as a human resources manager somewhere in northern Slovakia... In these general positions there is no difference, but in terms of more challenging jobs Bratislava is the place to be," says Huncik.

However, the rising wages in booming Bratislava go hand in hand with a rising cost of living. Real estate in the city is currently growing at a blistering 20% per year. Prices are shooting up so fast that some Slovaks have started relocating across the border to neighbouring Austria because it's cheaper to commute from there than live in their own capital city. It's a situation that would have been unheard of 10 years ago when the country was still reeling from decades of poverty under a communist regime. "It's shocking for me that we have same prices as in Vienna for real estate," says Huncik.

To some extent, the regional brain-drain has been tempered by the recent investment seen outside Bratislava, most notably in the auto manufacturing industry. Since 2005 when the gap in pay between Bratislava and the regions was at an all-time high of 39.88%, the figure has been steadily decreasing. In 2007, it had shrunk to 36.42%, according to figures from Erste Bank.

Yet the fall is not fast enough for Prime Minister Robert Fico's left-wing SMER party, which has introduced its policy of "equal pay for equal work," where employees are paid the same amount for identical jobs, regardless of where they are working. It's a policy Huncik despises. "This is not economics, it's a stupid theoretical concept," he says. "If the cost of living is cheaper in eastern Slovakia, why should we pay more or the same level as in Bratislava?" Despite the government's attempts, Huncik says all companies in the region are managing to legally get round the law one way or the other, whether through giving employees extra allowances or calling the same job a different name. "There are a lot of tools companies can use to avoid this governmental obstacle," he says. Companies will always be faster and smarter than government, says Huncik. "Especially our present government," he chuckles.

Cashing Czechs

The difference in pay within the borders of the Czech Republic is even more drastic than Slovakia, with average salaries in Prague in 2007 approximately 40% greater than those in the rest of the country at CZK21,692 (€867). Like Bratislava, wages are high in Prague as a result of a tight labour market coupled with a very low unemployment rate, currently around 3.5%, according to latest figures from the Czech Statistical Office.

It's a vicious circle, says Erste analyst Martin Lobotka. "First, you don't have much investment in the region, therefore the quality of the jobs are lower, and because the jobs are lower you're never going to get any qualified or talented people there," he says.

Despite this, Lobotka maintains that the gap in wages between Prague and the Czech regions is natural and a consequence of the popularity that capital cities tend to have across the world, especially with the young. "A lot of young people come to Prague to study and never come back - I'm one example," he says.

Like Huncik, Lobotka is also originally from a small town in Slovakia. He came to Prague to study economics and is now working on his PhD. "For me, returning back to Slovakia is not an option because I would not find a job relevant to my qualifications... it's not necessarily about the money, it's more about finding a satisfying job," he says, although concedes that such jobs generally do mean more money.

"This is a tendency you can see anywhere in western world," says Lobotka drawing attention to the same situation in the UK between wages in London and the North East of England. "Of course there's probably going to be closure to certain extent between Prague and the regions (hopefully) because of investment. But I don't see anything like that gap dropping below 20-5% in the next 20 years because the headquarters and management will still be located in Prague and keep wages high."

Poles apart

In Poland, the rapid growth in the size of salary packets since communism ended has also been marked by ever-widening wage differentials between regions.

The average monthly salary in Poland's most prosperous region, Mazowieckie, which contains the capital Warsaw, came to €1,042, according to figures for the first nine months of 2007 from the country's Central Statistics Office. At the same time, in the poor northeastern region of Warminsko-mazurskie, tucked away up near the Russian border, the average wage packet came to nothing more than €658. Figures such as these, says Jan Rutkowski, the World Bank's lead economist in the human development sector for Europe and Central Asia, illustrate the fact that wage differentials in Poland "are higher than in most European countries," and, reflecting a pan-European trend, are growing.

Part of explanation for this lies in the key role that economic development has had on widening the gap between rich and poor regions. Rutkowski points out that there is "a strong coloration between a region's investment level, its level of economic development and GDP per capita." So Warsaw and its immediate environs, which are naturally going to attract most investment, will boast higher wages than its more bucolic peers.

Further evidence of this can be found in the average wage packet of the Slask region, which contains the city of Katowice and much of Poland's industry. Here, a worker can expect to take home €862 a month while in the southeastern Podkarpacie region, which encompasses some of Poland's most impoverished if fetching, countryside, he or she will earn little more than €657. With this in mind, it comes as little surprise that the towns and regions in Poland that pay the most, are also the ones that have attracted the most investment.

The problem for anybody trying to close the gap between rich and poor areas is that once one area of the country has benefited from economic development and investment, the gap begins to widen with its own momentum. Investment has attracted further investment, which has sucked in skilled labour from Poland's rural heartlands, leaving only low skilled – and economically unappealing –people. At the same time, economists have bemoaned the tendency of successive Polish governments to try and fix the problem by raising the minimum wage – a policy, says Rutkowski, that comes with a price. "Trade unions and populist parties are saying that we require a certain minimum wage, but there is a trade off," he says. "Some people might say that the minimum wage should be increased, but this comes at a cost because the minimum wage may come close to the level of wages unskilled workers are receiving. If the wage is raised, then it might add to unemployment amongst the low skilled. Employers are loath to pay workers more than their productivity, which is often very low due to low skills."

To help bridge the gap, he adds, governments need to steer clear of increasing the minimum wage, and work at instead on attracting investment. "You cannot raise the level of wages artificially," says Rutkowski. "You have to invest in productivity and invest in skills in the regions. Policymakers need to work on the investment climate, remove the bureaucratic barriers, remove a number of bureaucratic obstacles because this will bring jobs and help raise the level of wages."

Hungary's Eastern promise

Hungary is perhaps even more centralised around its capital than its regional peers, something which has its roots in several of Hungary's one-time regional capitals, such as Bratislava (Pozsony, in Hungarian) having been lost through the Treaty of Trianon in the aftermath of WWI. Budapest is home to a fifth of the Hungarian population and is the Hungarian city to which people come to seek prosperity and the full spectrum of career opportunities, which in turn is reflected in the considerably higher wages in and around the city. However, beyond the capital, workers from the western part of the Hungary, although not on as high wages as those in Budapest, do earn considerably higher salaries than their eastern counterparts, with the possible exception of Southern Transdanubia. Many multinational manufacturers have favoured the western regions, partly for their proximity to western markets. For example, Audi's plant in the in Northern Transdanubian town of Gyor, which itself is close to the Austrian border, has its own rail connection that helps it shift goods across the border to Austria and onto its native Germany and beyond with ease.

However, foreign companies are increasingly tapping the east, which offers the same kind of highly educated and skilled workforce as the west, often to add to their first investments in the west. For example, Flextronics now has industrial parks at Zalaegerszeg and Sarvar in western Hungary, Nyiregyhaza in eastern Hungary, as well as one at Tab near Lake Balaton.

Budapest has become a hot destination for multinationals establishing global service and R&D centres, with competition intense for university graduates. BT, which has transformed from the widely derided British incumbent telecom into a global presence serving the ICT (Information & Communications Technology) needs of multinationals, made Hungary home to its only European global sourcing centre, which employs more than 250. The second part of the centre opened in the eastern city of Debrecen last June, to add to the Budapest wing. Divided between Hungary's two largest cities, it is strategically positioned to tap university graduates from universities, but also shows that there is considerable potential in the east as Budapest becomes saturated. "With the 'cheapest' country changing weekly, you'd go crazy basing global sourcing decisions purely on cost considerations," says Luis Alvarez, BT's president for Europe, Middle East and Africa.

Hungarian manufacturing giant Videoton, which produces many different kinds of products for big multinationals, is opening its latest new factory that will produce irons for Braun in Kaposvar in the western Hungarian region of Southern Transdanubia in April. Southern Transdanubia has the lowest average wages of the western regions, only marginally above the Eastern regions.

Meanwhile, northern Hungary, which includes the industrial city if Miskolc, is Hungary's unemployment blackspot (12.3%), followed by Southern Transdanubia (10%) and the Northern Great Plain (10.8%).

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