Wages and productivity diverge in their own directions

About 250,000 employees in state and public services will (again) receive higher wages in October. This time about three percent more. After last year’s wage mass growth of a historic 26 percent, this percentage seems modest and hardly worth mentioning. However, cumulatively, wages significantly ‘beat’ inflation: while price growth from 2021 to January 2025 reached 29 percent, wages have (nominally) jumped by a total of 50 percent. Thus, they have also outpaced inflation in real terms. However, this is not the case equally in the public and private sectors (more on that in a moment).

Growth has slowed down

To begin with, the latest trends. Economist Ivica Brkljača in a recent analysis states that the Croatian labor market is still marked by rising employment and wage levels, albeit at a noticeably slower pace than in the past two years. According to the latest data from the Croatian Bureau of Statistics, in July 2025, the number of employed compared to the same month last year increased by only 0.3 percent, which is significantly slower than in recent years (partly due to the new Foreigners Act, which has somewhat complicated their employment). On the other hand, the growth of average net wages is no longer double-digit: the average net wage for June (paid in July) was nominally 9.8 percent, and in real terms 5.9 percent, higher compared to last June. Thus, the growth rates are significantly lower than last year’s, but at the same time, they are almost double those in the years before the pandemic.

– Whenever I write about the movement of average wages, someone comments that most people earn less than the average. The average wage is like sarma: some eat meat, some cabbage, but on average, they eat sarma. Or: ‘I earn a thousand euros, Plenković five thousand euros. On average, we have three thousand.’ I am also entertained by some new, more creative comparisons that I have not heard before, such as: ‘The average wage is like a bikini – it covers the most important parts.’ I have no illusions that such comparisons will disappear, no matter how many times I repeat that the median wage is rising at approximately the same pace as the average. Moreover, the lowest wages have grown the fastest – Brkljača is vivid.

Less and less remains for investments

The fact is that no one would make a drama out of wage growth if it flourished from productivity growth. It is also a fact that their growth is slowing down, but since wages and productivity do not drive parallel at all, rather, they diverge in their own directions, the question of the limits of their growth (or, translated, how much more wage growth the economy can bear) is indeed legitimate. Since the entire wage growth, not only for employees in the private sector but also for all in the public sector, is financed through taxes from the private sector, the question of the economy’s endurance is actually a question of the endurance of private companies. Most of them are from the small and medium sector, whose capital reserves are not exactly up to the task, so the key question is how much this part of the real economy can raise wages. How much more room for wages is left? Since this is not a topic they like to discuss publicly (they must be ‘politically correct’ so as not to offend employees), some have spoken anonymously.

The owner of a small company in the wood industry says that there will always be money for wages, including their growth, because as long as the battle for people continues, wage growth is one of the trump cards for attracting and retaining them.

– We export most of our production, mainly to Germany, Italy, Switzerland, and the Scandinavian market is slowly opening up. So, there are orders for now, despite all the uncertainties. Although the inflow from sales is secure, most of the earnings go to wages and other input costs, which continue to rise, from raw materials to energy. Less and less remains for investments. We have been postponing the purchase of modern machines for two years, and without them, our productivity is falling. Namely, although we have raised wages for fifteen employees several times in the last two years, the wood industry is not attractive. No one from the locals wants to do such jobs anymore, so we have no choice – the interlocutor is resigned.

A similar calculation is made by an entrepreneur from the chemical industry.

– In the last two years, we have raised wages on average by almost 20 percent. I don’t know where the limit is; without people, there is no work, but to maintain competitiveness, I would need to invest a larger part of the income in development and new technology. The lag is not too great for now, but if I continue to allocate a large part of the income for wages and their growth next year, we will lose the game in part of the market – the interlocutor is categorical.

Decline in labor productivity

No economist wants or can draw a ceiling to which wages can jump. Because if we live in a market, then wages rise as much as they need to rise, or as much as the labor market dictates. This is what classical economics would say. But there is a small problem: wage growth does not stem from productivity growth, but from a lack of supply in the labor market. The headache is that wage growth has been highest in the public sector, which has not recorded any measurable productivity growth. How long the private sector will be able to sustain such growth from which the public sector reaps the benefits is not precisely clear for now. It is only clear that Croatia has been flaunting at the top of the EU in terms of nominal wage growth for some time, which is why inflation is more stubborn than elsewhere in the Union.

So, what do employers think about the whole thing? HUP’s chief economist Hrvoje Stojić estimates that Croatia will grow by two and a half to three percent this year, but this growth is built on increasingly weaker foundations – declining productivity and weakening competitiveness.

– State interventions in the form of an explosion of wages in the public sector and a strong increase in the minimum wage artificially raise the cost of labor, which stifles investments and the competitiveness of the economy. The consequences are already visible: some plants in the manufacturing industry, such as textile and metal processing, have had to close their doors. Croatia must stop artificial interventions in labor costs if it wants to maintain long-term competitiveness – Stojić emphasizes.

He adds that total employee compensation last year jumped to almost 50 percent of GDP, up from 45 percent in 2022, thus exceeding the relatively stable average of the European Union of 48 percent of GDP for the first time. This has further deepened the gap compared to the average in the CEE region, where compensation amounts to 43 percent of GDP.

– Croatia records the largest gap between the growth of the minimum wage of 10.1 percent and the growth of gross added value per employee of only 6.7 percent, which clearly indicates a decline in labor productivity. Also, Croatia is only at two-thirds of the average productivity in the EU, below the average of the CEE region of 72 percent, with extremely large differences among sectors. The manufacturing industry is particularly in an acute position, where the average GVA in the last three years has reached only 31 percent of the German average. Additionally, the profitability of Croatian companies per employee is half lower than the EU average and a quarter below the average of the CEE region. Margins in the real sector are stagnating or falling, and in tourism, for example, wages are rising significantly faster than revenues. All this seriously reduces the capacity for new investments. In the coming period, in which European public investments will slow down, Croatia has no choice but to open space for private investments. The only path to sustainable growth is lower taxes in the function of employment growth, lower energy costs, and an incentive system for investments that must be more attractive than that in most European member states – Stojić clearly states.

Exporters are losing competitiveness

The whole picture is rounded off by another piece of data – Croatia ranks only 51st on the world competitiveness index. Export companies are increasingly struggling to keep up with competitors from the CEE region whose economies show stable productivity growth. Many economists are already warning: if labor costs continue to rise faster than productivity, we will face price pressures, declining profitability, and loss of market share. This will not only affect exporters but the entire economy – in the form of fewer investments, slower growth, and fewer opportunities for new jobs.

All this leads to the conclusion of ‘Animal Farm’: we are all equal, but some are ‘more equal’. Namely, while wages in the real sector must adjust to productivity and market conditions, the public sector generally enjoys greater protection due to collective agreements and budget revenues. Analysts from Raiffeisen Bank state that the pronounced wage growth in the public sector raises questions about the sustainability of such a trend, especially in the context of the structure of the state budget, particularly its expenditures.

– The share of wage and pension mass in total budget expenditures is already extremely high, about two-thirds of total expenditures, and any new increase reduces the space for development and investments, such as investments in infrastructure, education, healthcare, or green transition. This is risky, especially in the downward phases of the economic cycle, particularly considering that budget financing relies on consumption taxation. Additionally, it long-term limits the potential for increasing productivity across the entire economy. Potentially, the continuation of such a trend could cause rising fiscal burdens due to the rigid structure of budget expenditures, increased borrowing to cover the budget deficit, which ultimately leads to rising public debt and undermines the fiscal position of the country. In other words, wage growth can only be sustainable if it is accompanied by productivity growth and rationalization of public spending. Otherwise, there is a risk that the short-term wave of wage growth will create long-term imbalances that will limit fiscal space and reduce the state’s ability to service debt and public services – they are categorical at RBA.

We are spinning the inflation spiral

The real upper limit of wage growth that the real sector can withstand, as analysts at RBA claim, is largely determined by the productivity and profitability of companies. When wages rise faster than productivity, especially in sectors that are directly exposed to competition and market pressures, companies face higher, increasingly rising production costs. This can reduce profit margins and, ultimately, limit the capacity for additional investments and employment. Or, conversely (with unchanged profit margins), faster wage growth compared to productivity spills over into the prices of goods and services, which can intensify inflationary pressures.

The rise in inflation can, in turn, cause an increase in interest rates through monetary policy, which consequently further burdens the real sector by increasing financing costs. A spiral, therefore. Although no one wants to utter a word about the inflation spiral (the race of rising prices and rising wages) for now, the fact is that we are long-term spinning precisely that spiral. But long-term, as the meaning goes, is on a long pole, currently not visible to the eyes. And far from the eyes – far from Mark’s Square.