Why Are Labor Markets Tight in Central and Eastern Europe

Why Are Labor Markets Tight in Central and Eastern Europe — Policy and Business Implications

March 25, 2019

In our previous blog on Central and Eastern Europe (CEE), we showed the severe tightness in its labor market and how real wages have strongly accelerated over the past two years. In this blog, we will discuss why labor markets in CEE have become so tight and what implications business leaders and policy makers should be aware of.

In this blog, we have divided Europe into the following three regions. Central and Eastern Europe (CEE) consists of Bulgaria, Croatia, Czechia, Estonia, Hungary, Lithuania, Latvia, Poland, Romania, Slovenia, and Slovakia. Northern and Western Europe (NWE) consists of Austria, Belgium, Denmark, Finland, France, Germany, Ireland, the Netherlands, Norway, the UK, and Sweden. Southern Europe (South 4) consists of Greece, Italy, Portugal, and Spain. For the labor market indicators shown in this blog, the regions are weighted according to each country’s share in real GDP.

Why do we see such a tight labor market in CEE?

CEE has especially benefited from the recovery of the Euro Area: Economic growth accelerated to around 4 percent in 2016 (Chart 1), showing the strong demand for CEE goods and services since the Euro Area recession ended in early 2013. In the last 2 years the region has further accelerated.

Chart 1: Economic growth, 4-quarter moving average, 2000Q1 to 2018Q4.

Chart 1

Note: Due to missing data, the UK, Croatia, and Italy are not included in the regional averages for 2018Q4.

Source: Eurostat.

While demand is strong, labor supply is shrinking: Even though demand is strong, an especially tight labor market has made it harder for businesses to hire. As a result, employment growth has started to slow down since the end of 2017 (Chart 2). Part of the labor market tightness can be explained by the current stage of the business cycle—after a 5-year expansion we would expect labor markets to be tighter. At the same time, the current labor market situation in CEE has been intensified by CEEs terrible demographic trends— a fast aging workforce and net outward migration.

Chart 2: Employment growth, 2000Q1 to 2018Q3.

Chart 2

Note: Employment is based on labor force survey data.

Source: Eurostat.

An aging workforce—Chart 3 shows the 5-year growth rates of the working-age population from 2008 to 2028 in which both natural population growth and migration are included. The grey bars illustrate that the working-age population shrank in CEE countries in the last decade. In the next 10 years these trends are only going to accelerate further as is depicted by the blue bars. Especially Lithuania, Latvia, Bulgaria, and Romania will have a much smaller share of the population available to work.

Chart 3: Working-age population (20-64) log growth rate, 2008 to 2028.

Chart 3

Source: Eurostat, calculations by The Conference Board—actual population estimates up to 2017, baseline population projections from 2018 onwards.

The demographic slowdown is mostly caused by the large baby-boomer cohort that is now retiring and the smaller size of the generation that will take their place. Chart 4 shows the ratio of people aged 60-64 to 15-19—the people who will exit and enter the working-age population between 2018 and 2023. Slovenia, Bulgaria, and Latvia have the highest exit/entry ratio in the world. The demographic slowdown in CEE countries is much more severe compared to most countries in NWE. Note that compared to almost all European countries, the demographic trend in the US is quite favorable.

Chart 4: The ratio of people aged 60-64 to 15-19, 2018.

Chart 4

Note: 2018 is projected.

Source: United Nations World Population Prospects 2017.

Net outward migration—While aging is the main driver of the shrinking workforce, net outward migration in most CEE countries is also contributing to the demographic declines. Chart 5 shows the net migration flows from 2013 to 2016 as a percent of the population, distinguishing between nationals and other EU citizens moving in or out of the country. Especially in Latvia and Lithuania, many nationals left the country after the Great Recession. From 2013 to 2016 [1], these two countries saw an outflow of about 2.5 percent of their population. Romania, Croatia, and Poland have less but still a considerable outflow of people with 0.5 to 1.5 percent of the population.

Chart 5: Net migration flows as a percent of the total population, sum of the period 2013-2016.

Chart 5

Note: Net migration as a percent of the population, summing up 2013 to 2016. Non-EU citizens were excluded from the analysis.

Source: Eurostat.

What does the loss of CEE workers mean for business in 2019 and beyond?

Wages are rapidly accelerating: Amid severe labor market tightness, worker bargaining power has increased which is one of the reasons why wage growth has accelerated to over 10 percent, five times faster than anywhere else in Europe (more information in the first blog on CEE).
Decreased competitiveness: With labor markets tightening and labor costs rapidly rising, the advantage of lower labor costs compared to the rest of the continent will further shrink over time and could mean that businesses will shift operations elsewhere.
Companies are automating: Rising labor costs and a shrinking labor pool have forced companies to automate. Data on labor productivity shows that businesses have already implemented labor replacing technologies to get more out of their existing workforce (Chart 6). However, labor productivity growth of just under 4 percent has still not been enough to offset the need for more workers.
Europe is slowing down in 2019: Economic growth in Europe is projected to slow down in 2019.[2] This means that CEE will experience decreased demand, and as a result, slower employment growth in 2019. At the same time, modest employment growth will be enough to further tighten CEE labor markets as the working-age population is shrinking.
People on the sideline will enter the workforce: Participation rates have continuously increased because of a higher share of older workers that are entering the workforce, more females that are participating, and there is a continuous upward trend in higher education completion rates which increases the chance to find a job and thus participation.
Increased immigration?: While CEE is rapidly aging, it is unlikely to see increased immigration from outside the European Union in the current political environment. On the other hand, better labor market conditions in CEE could limit outward migration.

Chart 6: Output per hour worked, 4-quarter moving average, 2002Q1 to 2018Q4.

Chart 6

Note: Because of missing data, Belgium is not included in the NWE weighted average. 2018Q4 is not available for Italy and Croatia.

Source: Eurostat, calculations by The Conference Board.

[1] Migration data by citizenship is only available from 2013 onwards.

[2] To learn more about the economic outlook for Central and Eastern Europe, read The Conference Board Economic Outlook for Europe.

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