Wage Indexation: Too Much Social Sensitivity Leads to an Inflationary Spiral

A few months ago, the European news portal Politico.eu and the German tabloid Bild caused quite a stir in the European media space by announcing that salaries for nearly 50,000 officials and dignitaries of the European Union are being adjusted for inflation in Belgium and Luxembourg, increasing by 6.9 percent. It was later clarified that this is not entirely accurate, as the salaries of EU officials and dignitaries are not adjusted for inflation, but rather, according to a predetermined system for calculating salary adjustments, with the movement of salaries of public officials in member states, which brought them an increase of 4.4 percent. Regardless, we learned that the salaries of EU officials and dignitaries are indexed.

In Belgium and Luxembourg, countries where most EU officials work, wage indexation in the public sector is traditionally present. Indexation is linked to the movement of wages in the private sector or to the rise in the cost of living. Malta has a similar system. In Croatia, public officials are not so fortunate, as the growth of their salaries depends on negotiations between unions and the Government.

In recent years, the ‘wet dream’ of unions has been to index the salaries of public employees to GDP growth, and during the last such negotiations last autumn, some union leaders proposed that the agreement on salaries for this year include an automatic salary increase aligned with inflation growth. It did not pass, but unionists do not give up on the idea that salaries should grow not only according to the inflation rate but also above it.

However, wage indexation to the inflation rate is a battleground where multiple economic laws clash. One of them states that wage growth would protect the real purchasing power of income, which can prevent a decline in consumption, or recession, as consumer spending is the most important component of forming Croatian GDP.

– I would not rely too much on that assumption, as even with real unchanged wages, people in uncertain circumstances spend less, save wherever they can, and give up on necessary purchases, so wage indexation will not reduce the decline in GDP and prevent the slowdown of its growth, which is likely this year. The spiral of wages and prices fuels inflation and does not increase real GDP, which has been proven multiple times in history. Wages are a cost for companies and affect the formation of prices paid by consumers, and this inflationary effect cannot be compensated by lower prices of imported goods that reduce the overall inflation rate, as well as reduced inflation expectations due to restrictive monetary policy measures and tightening credit conditions. Therefore, the risk of accelerating inflation is greater in the case of wage growth,” says Marijana Ivanov, a professor at the Faculty of Economics in Zagreb.

Moreover, according to the calculation of the chief economist of the Croatian Chamber of Economy, Goran Šaravanja, just to maintain the level of purchasing power from 2021, wages would need to increase by almost 12 percent this year. His calculation stems from the fact that despite a nominal growth of over seven percent, real wages fell by approximately 3.5 percent last year, and the weighted average projection for inflation in 2023 for Croatia is 6.8 percent.

– However, in conditions of slowing economic growth and when the European Central Bank raises the reference interest rate, I do not see that entrepreneurs and the Government can increase wages that much – notes Šaravanja, who therefore does not expect that an inflationary spiral will arise in Croatia due to wage growth, which is another economic law that goes hand in hand with wage increases during inflation.

However, here, as a sort of disruptor, a third economic law appears: in a situation where there is not enough labor force in the labor market, employers are forced to raise wages to at least retain employees so they do not flee to countries where purchasing power is greater than in Croatia.

The management of INA recently reported that, after successfully concluding negotiations on amendments to collective agreements with social partners, it decided to increase the net earnings of workers in nine companies within the INA Group by 11 to 16 percent (depending on the company).

– We are aware of the consequences that global economic trends and inflationary pressures have on the earnings of our workers and we want to increase their sense of security in a rapidly changing environment. Our goal with these changes is to ensure INA’s competitiveness in the labor market by successfully retaining talent and attracting new ones more effectively,” explained Péter Ratatics, CEO of INA.

INA is not the only one that has recently agreed to such a high increase in employee earnings for this reason. Many other large and small companies have done the same. There is hardly a week that goes by without a statement from some company arriving in Lider’s emails announcing that it has decided to raise salaries for its employees to ease their lives in inflationary conditions. Social responsibility towards workers has evidently gained momentum in Croatia in recent months, which is very nice and commendable, but economically speaking, too much social sensitivity is the wrong reason for increasing wages. It is wrong both due to its impact on (non)competitive business operations of companies and due to the impact of wage growth on macroeconomic trends.

– In practice, inflation generally converges towards the difference between the rate of growth of the wage mass and productivity growth. Due to the long-term productivity growth rate in the euro area of only one percent, wage growth greater than three percent can easily be inflationary,” states Hrvoje Stojić, chief economist of HUP.

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