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Salaries: How Much is Enough?

Who would not want a higher salary? There are, however, two sides to the same coin regarding salary growth: one is an increase in living standards and the other an impact on production costs and competitiveness. While trade unions will, by the very definition of their existence, always call for higher salaries, corporate management is rewarded for generating profit for the owners of companies. The key issue is finding the right balance between both.

After the lean years of 2012–2013, when the average salary decreased in real terms, salaries have been on the up and up again these past three years. As long as salary growth goes hand in hand with an increase in labour productivity, all is well. Salaries combined with productivity are an indicator of unit payroll costs, which, in simple terms, says how much staff costs need to be incurred for a certain amount of production. Between 2013 and 2015, unit payroll costs experienced a downturn. However, they began to go up again last year, returning to the long-term trend where salaries take an ever larger portion of the cake. Between 1995 and 2016, unit staff costs rose by more than 7%. Yet, on an international scale, some people may still think that Czech salaries are low. The question is whether this is true and, if so, what is the reason?
 
Emotions are stirred particularly when GDP and salaries are compared to those of other EU countries. While, in terms of GDP per capita taking into account the differences in purchasing power, the Czech Republic reaches 88% of the EU average, the figure is only 65% of the EU average in terms of the average salary. How can this be? Before we take to banners and start threatening to go on strike, let us consider a few numbers.
 
The Czech economy is sometimes labelled as an “assembly shop”, by which reference is usually made to the low added value in the final production. The share of added value in companies’ aggregate revenues (an analogy of the gross margin used in financial analysis) amounts, at the Czech economy-wide level, only to 39%, which is the lowest figure in the entire EU. This is in a context where added value is a cake divided into remuneration for work and capital (leaving aside the government, which claims part of the cake by collecting taxes). From the perspective of companies, the key issue is whether they are able to generate as much profit, or more, as in other countries. The EBITDA margin at the economy-wide level is thus highly similar in most EU countries. In the Czech Republic, the economy-wide EBITDA margin is at 21.6%, with the EU average at 21.7%. At the current level of salaries, companies in the Czech economy are able to generate average profits.
 
If salaries kept growing faster than productivity, ie if unit staff costs kept increasing, companies’ profitability would fall below the average. In other words, the Czech Republic would become less attractive for the existing companies as well as new investors. To prevent this, salaries may grow by an average of 4-5% in the years to come.
 
With elections looming, politicians are tempted to join trade unions in calling for higher salaries. It does not cost them anything. However, if they truly wish to sustainably increase living standards over the long term, they had better give thought to how economic growth may be accelerate and how to help gradually turn the Czech Republic from an “assembly shop” to a more modern economy – before automation and digitisation do it themselves, albeit at a greater social cost.

David Marek, Chief Economits, Deloitte