European Affairs

European Affairs

Winter/Spring 2005

 

European Perspectives
Europe's East-West Pay Gap is Narrowing
By Robin E. J. Chater

 

One of the wisest British thinkers of the 19th century, Thomas Carlyle, wrote that the progress of human society consists in the"better and better apportioning of wages to work." Many generations later, Europe has still not progressed very far in that direction. The amounts people are paid are among the fundamental dynamics of any society and should be very easy to justify. In a market economy, revenues from the sale of a successful company's products and services, minus material and other external costs, generate an operating surplus. After allowances for profit and charges such as social security and pension contributions, the remaining funds may be allocated to individual wages and salaries. In a well-run enterprise, some funds will be set aside for performance bonuses and the rest distributed on the basis of know-how, responsibility, competence and hours worked.

The problem is that this approach is seldom, if ever, adopted. European pay levels are more likely to be determined by reference to commercial pay surveys and through collective bargaining. In some countries, minimum wage rates exert a major influence, in others they are too low to be relevant - statutory minimum rates range from around ten percent of median pay in Russia to 57 percent in France - and some countries do not have them at all. In Scandinavia, Germany, Italy and Austria, the only formal constraints on the bottom of the pay market are those set through collective agreements.

Although its importance is diminishing, collective bargaining is still the main determinant of blue-collar and junior white-collar pay throughout much of Western Europe. The exception is the UK, largely because sectoral bargaining broke down in the 1980s under Prime Minister Margaret Thatcher, following a period of industrial unrest in the late 1970s.

In much of Central and Eastern Europe, on the other hand, the collapse of state-dominated trade unions since the fall of communism in 1989 has left both sectoral and company collective bargaining in a state of flux. In many new EU member states in Central and Eastern Europe, pay is set by local employers working loosely together to hold wages down. This process, however, is being progressively undermined by inward-investing enterprises. The new foreign investors are making such huge savings in labor costs that they can afford to cream off the best workers by ignoring local wage cartels and paying more.

The Federation of European Employers (FedEE) has been monitoring pay trends in more than 40 European countries for the past six years. During that time there has been a significant narrowing in the overall pay gap between the poorest countries (Belarus, Bulgaria, Moldova, Romania, Russia, Ukraine and many of the new EU member states) and the richest countries (Denmark, Germany, Norway and Switzerland).

The trend is clearly confirmed in the Federation's latest report, Pay in Europe 2005, published in March 2005. In 2001, for example, pay in Denmark was 39 times higher than in Romania, while today the gap has narrowed to just 22 times. The report tracks median pre-tax hourly wages for 31 job positions, in three different sizes of companies, in 48 countries. The figures reflect the position on February 1, 2005.

There are four main reasons for the narrowing of the European pay market:

Median Employee Earnings League
Table: February 2005
Position Country Earnings Relativity
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30
31
32
33
34
35
36
37
38
39
40
41
42
43
44
45
46
47
48		 Denmark
Switzerlan
Norway
Liechtenstein
Isle of Man
Luxembourg
Guernsey
Germany
Sweden
Netherlands
Italy
Jersey
United Kingdom
Faroe Islands
Belgium
Finland
Austria
Ireland
France
Iceland
Spain
Gibraltar
San Marino
Cyprus
Andorra
Greece
Slovenia
Malta
Portugal
Croatia
Hungary
Czech Republic
Poland
Turkey
Slovak Republic
Estonia
Bosnia Herzegovina
Lithuania
Macedonia
Latvia
Romania
Russia
Bulgaria
Belarus
Serbia
Albania
Ukraine
Moldova		 100
83
77
74
70
69
68
67
59
58
56
56
56
56
53
53
53
51
48
46
39
36
34
30
29
25
22
20
19
14
13
13
11
11
11
9
7
6
6
5
5
4
3
3
3
2
2
2
©Copyright:FedEE Services Ltd 2005 All world rights reserved
Median pre-tax hourly wages for 31 job positions in three different sizes of companies.

As the table shows, a huge divide remains between established EU countries, such as Germany, Italy and the UK, and countries in Central and Eastern Europe, such as Poland and Hungary. In the most extreme case, the richest country, Denmark, pays 61 times the median rate in the poorest country, Moldova (The exceptionally high Danish wage levels reflect the unusually strong grip of sectoral collective bagaining agreements in Denmark, and the fact that employees pay more in taxes and social security than in any other EU country, while employers make only token social security contributions, giving them more scope to pay high wages.). For the majority of European employees, however, living standards are gradually being harmonized and rewards for skills are increasingly coming to reflect market values.

Nevertheless the East-West gap has not yet narrowed enough to remove the huge incentive for industrial enterprises, particularly in France, Germany, the Netherlands, Scandinavia and the UK, to shift their operations to Central and Eastern Europe. Although there may be concerns about political instability, lack of security and corruption in some of the least-developed states, there are few barriers to establishing a business in countries like Poland, where median hourly pay is just 17 percent of the level in Germany.

It is curious, therefore, that only a few major Western European employers, such as IKEA, Electrolux and Peugeot Citroen, have so far taken advantage of the opportunity to cut costs by shifting production or central supply chain distribution points to Central and Eastern Europe.

Although U.S. companies are waking up to the potential of Central and Eastern Europe, they are still concentrating investment in high-cost centers such as Germany. A recent survey by the American Chamber of Commerce and Boston Consulting Group found that 26 percent of U.S. companies based in Germany considered Central and Eastern Europe the most important region for corporate investment. But 40 percent still planned to increase their investments in Germany in 2005, and nearly a third had spent more than 40 percent of their entire European investments in Germany over the previous 12 months.

The "apportioning of wages to work" in Europe remains far removed from the simple distributive model outlined above. At best, an annual salary budgeting approach is used, so that any increase in the amount allocated to wages is broadly in line with projected company performance.

When employers bring these data to bear on industry-wide collective bargaining, it also means that pay rates will not move slavishly in line with retail price inflation. There is nothing in this process, however, to prevent the perpetuation of excessive wage costs, and European companies could soon find themselves ill-equipped to confront international competition.

Collective bargaining made sense when its objective was to keep competitors out of a job market, or force them to pay comparable rates. Now, however, in the globalized business environment of the 21st century, sectoral wage and salary scales no longer have any value or meaning for private sector enterprises. If the European economy is to survive the onslaught from Indian and Chinese production centers during the next ten years, companies must act swiftly and take what advantages they can from improved pay determination methods and what remains of the East-West pay divide in Europe.

Robin E. J. Chater is Secretary General of the London-based Federation of European Employers (FedEE).

The opinions expressed in this article are entirely those of the author and do not necessarily represent the views of FedEE or its corporate members.