Drifting Apart: The Eurozone's New Inflation Problem
Julius Probst, PhD discusses wage dispersion across labor markets in the Eurozone and what that means for recruitment.
Hi, I am Julius. I am a Senior economist at Appcast, based in London. I write about global labor markets (with a focus on the U.S., U.K. and E.U.).
Photo Credit: Christian Lue
First of all, big congratulations to Bulgaria as it became the 21st Eurozone member on January 1!!!
Without a doubt, the Eurozone project has been a stunning success. The region now accounts for 360 million people and a GDP of more than €15 trillion, making it the third-largest economy in the world.
Despite the Eurozone crisis more than a decade ago, another six countries in Southern and Eastern Europe have joined the club since 2009.
The appeal for these economies is obvious as many of them have experienced a volatile inflation history. Euro membership promises stable prices and lower interest rates, with obvious benefits for both the public and private sector. However, with growing membership, a new problem is now threatening the Eurozone: economic divergence!
Eurozone inflation rates have diverged
In the years preceding the pandemic, inflation rates across the Eurozone were not too dissimilar: the difference between the highest and lowest inflation countries was a mere 2 percentage points.
That changed with the global macroeconomic shocks Europe has been exposed to in recent years, including the energy price crisis following COVID and the war in Ukraine. The Baltics saw their inflation surge to above 20% in 2022 while the average Eurozone inflation rate was about 10%.
Even with average inflation now back at the 2% target, some countries are seeing inflation rates above 4% (Croatia, the Baltics) while others are close to 0% (Cyprus): the gap has widened.
Ditto for wage growth
Naturally, higher inflation countries are also recording higher wage growth — workers do not enjoy losing purchasing power! Wage growth for job advertisements is showing significant divergence across Eurozone economies, ranging from less than 2% in France to almost 5% in the Netherlands and Ireland, for example.
Some countries are booming while others stagnate
The disconnect between the North and the South is not just about inflation and wages, but also economic growth.
Even when disregarding obvious outliers like Ireland — which is booming because of its status as global tax haven — many countries in Southern and Eastern Europe have grown by 10% or more since 2020. On the other hand, the core Eurozone economies like Germany and France, together with parts of Northern Europe, have been stagnant.
Due to lower living standards, economies in Southern and Eastern Europe are expected to grow faster to catch up with the rest. But the pace of convergence is stunning. Poland is growing at a rate of 3% and has overtaken Japan in terms of per capita GDP. Spain’s economy is also enjoying an enormous economic revival.
After a decade of stagnation, Southern Europe is not just enjoying a tourism boom. Economic dynamism generally seems to have been revived. Labor markets are healing as the region boasts the lowest unemployment rate in decades.
Why divergence is so hard to fix in the Eurozone
Economists have criticized the Eurozone’s institutional setup right from the start. Economic theory suggests that a common currency only makes sense for geographies that have a high degree of economic integration: high labor and capital mobility, high inter-regional trade flows, similar institutional setups, etc. These features are necessary for economies to deal with shocks that affect regions unevenly.
The U.S. largely qualifies. If one state gets hit by a large economic shock, depressing the local labor market, workers can easily migrate and find work elsewhere. In the Eurozone, by contrast, language, cultural, and institutional barriers sharply limit cross-border worker mobility. The result is that local shocks tend to persist. After the Global Financial Crisis, unemployment in parts of Southern Europe exceeded 20% for years, while countries like Germany or the Netherlands remained close to full employment.
This lack of adjustment mechanisms makes divergence especially problematic in a currency union. The European Central Bank must set one interest rate for 21 very different economies. Inevitably, this “one-size-fits-all” approach creates problems: monetary policy is too tight for weak economies that need stimulus and too loose for booming ones that face inflationary pressures. Rather than smoothing economic conditions, uniform monetary policy is creating boom and bust cycles — prolonging downturns in some countries while fueling overheating in others. This tension pitted Germany’ stronger economy against weak economic growth in Southern European during the Eurozone Crisis and has now resurfaced in the post-pandemic recovery.
In principle, national fiscal policy could help offset these imbalances. Governments in weak economies could stimulate demand, while those in fast-growing regions could tighten policy to prevent inflationary pressures.
In practice, though, fiscal policy is riddled with problems. Spending decisions are slow, politically constrained, and often inefficient or outright wasteful. Even countries with low public debt like Germany are struggling to implement fiscal stimulus in a timely manner despite a two-year long economic downturn.
Conversely, governments are rarely willing to tighten policy in a boom. Few politicians have the courage to take the punchbowl away when the party is going.
The experience of the early 2000s illustrates the risk. Capital flows into Southern Europe amplified booms, inflated asset prices, and created credit bubbles that ultimately collapsed. While growth is more balanced today, the same structural forces remain in place. With limited worker mobility, a single monetary policy, and ineffective fiscal rules, the Eurozone will struggle to prevent today’s divergence in inflation, wages, and growth from becoming entrenched —– potentially sowing the seeds of the next crisis.
What does that mean for recruiters?
Recruiters hiring in Europe always had to pay attention to each individual market due to different hiring regulations, wage-setting behavior (collective bargaining or not), and local laws and institutions. However, at least inflation and wage growth were not too dissimilar across Eurozone economies before 2019. But that has changed now!
Economic uncertainty remains high and inflation and wage growth are volatile in the post-pandemic world. Recruiters need to pay more attention to national conditions as Eurozone economies have diverged significantly. This requires more careful workforce planning and salary benchmarking by country, or else risking being left behind in a competitive talent market that shifts more quickly than before.