What salary increase do I have to implement this year?

The first trimester of 2022 was defined by huge inflation. This was due to many factors: the Ukrainian war and the recovery after COVID-19, among them. Prices have been increasing heavily. However, salary increases are not growing at the same pace.

Why is this happening? Are there any intrinsic factors? Do all countries follow the same tendencies? This article will try to answer these questions and create a general overview of the economic situation for businesses.

Situation of inflation in Europe

Inflation in Europe started rising at the begining of the year due to the increase in the prices of fuel and energy. This increase was fueled even more fiercely following the Russian invasion of Ukraine. 

Inflation in Europe in March 2022 was 7.5%, coming from a 5.9% in February 2022. If we divide inflation by sectors we get that the higest one is energy: it has a 44% inflation rate.

Other elements have rates way lower: 5% for food, alcohol & tobacco; 3.5% for non-energy industrial goods and 2.5% for services. It is clear than current inflation is determined by energy, which is highly related to Ukraine.

Having said that, even underlying inflation rate (the one that does not take into account energe or unprocessed food) has grown. This shows how the increase of energy prices affects other products.

The inflation in some European countries was already really high (Lithuana, Estonia, Latvia). In others, it is still controlled but growing at an enormous pace (the Netherlands and Spain).

The following map shows the monthly increase (from February 2022 to March 2022) of inflation in some Euroean countries. The higher values are found in Spain and specially in the Netherlands. The only country with a negative rate is Slovenia (with -0.4% of inflation in respect of February).

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Monthly rate (%) of increase of the inflation rate measured by the HICP. Datasource: eurostat.

Diference in general inflation against salary increase

Logic says that since wages are in fact prices, they should grow when prices increase. This would mainain the populations purchasing power at the same level. However, this does not happen. 

Economic theoretical explanation

Inflation and salary increases are not the same. Even if they generally move in the same direction, they are driven by different inputs:

• Inflation represents changes in the cost of a market basket of goods (such as groceries and fuel). 
• Wages, on the other hand, are driven by changes to supply/demand for labor which can be caused by demographic trends, labor participation rates, technological advances, and growth in productivity. 

There are many historical moments where these two imputs were completely different. For example,  in 1979, U.S. inflation was 13.3% but US wage increases were a much lower 8.7%. On the other hand, in 2020, US inflation was a low 1.4% but US salary increase budgets were higher (between 2.5% and 2.8%). 

Employees benefit in the periods of low-inflation while having difficulties druing high-inflation years. Currently, Europe is exeriencing on the the high-inflation periods.

There are other factors that push this two values to be different. One statement that is usually made is that “wages are sticky”. It means that they do not tend to change drastically unless significant structural issues are present. Both companies and employees aim for stability. This produces many differences with respect to inflation.

This information of this section was based on the theory explained in the article “What salary increases do not keep pace with inflation?” by Forbes.

Real cases of salary increase and inflation

We will use Spain as an example of the situation in Europe. Inflation in Spain now hovers around 10 percent. Whereas salary increases in 2022 have only been raised by 2.4 percent on average. Salaries are expected to grow just below four percent.

Predictions say that the inflation will stabilize around the month of July. Then, salaries will start to be revalued and the situation will be solved by the end of the year.

The sectors that had low salaries before, are the ones that are growing the least. For example, jobs in bars and restaurants have had a salary increase of 1% and agriculture jobs about 1.6%. At the other end of the specturm, the shipping industry has increased 3.5%, construction 3.2% and factories 3.1%.

Salary increase in Europe

From this evolution of salaries, we can see that cities that had low salaries (Barcelona, Madrid and Prague) are increasing at a fastest pace than cities with high salaries (Berlin, Paris and Amsterdam). Especially Prague has increased from 20k€ salaries to 40k€ salaries in three years. We could say that these are emerging cities.

On the other side, high salaries are growing. Nevertheless, they are not growing at the same rate as the inflation rate. In the case of Amsterdam, salaries have increased 1.63% in the three first months of 2022, while the montlhy inflation rate growth is 4.7%.

From this high-salary group, we can see that Amsterdam and Berlin are leading the market and Paris is being left apart.

Another consequence of the fact that low-salary countries increase faster than the rest is that the gap between both groups is diminishing. 

The biggest insight from this graph is that the prediction for the future year (grey area) is that salaries will grow at the same rate as they are currently doing. If inflation keeps increasing, the purchasing power of workers in Europe will decrease drastically.

The growth rate in European salaries

This graph shows the increase of the last two years and the prediction of the following year for Software Developer salaries.

All cities have diminishing growth salary rates except for Paris. Having said that, Berlin and Paris have rates lower than 5%. Amsterdam has been still for these three years, their growth rate is stable.

Barcelona and Madrid have values really similar to each other, around a 10% growth rate. Finally, Prague has the highest growth rates but they have been decreasing heavily later.

Recommended salary increase

Rutte (the Netherlands Primer Minister) told the press in March 2022 that he felt Dutch and international companies in the Netherlands should do what they can to increase the salaries of employees, as many businesses are thriving: “I think it’s the job of a decent employer to pass [profits] on via wage increases.”

The conclusion would be that it is extremely difficult to base salary increases on inflation. If high inflation persists for some months, a raise would be needed for sure. However, the wage increase is likely to be lower than the inflation rate. 

Moreover, depending on the city different values would be recommended. It depends on many factors, not only inflation. However, the minimum requirement would be that the growth rate should be kept consistent with previous values.

It is really hurtful that the salary growth rate decreases at times when the inflation rate is growing; this should be changed and have these two varies growing in the same direction.

One of the best ways to keep salaries updated is to keep an eye on salary benchmarking guides or platforms. To check what wages are paying the competitors and do not miss any trends. This could have a negative impact on attracting and retaining talent.

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