Global trends in pay: Does inflation still act as the key driver for salary increase?

The latest pay trends in Europe and Asia

October 4, 2016

There’s a view among many Western economists that inflation is yesterday’s issue; that we’re embedded in a low-inflation environment, and will remain so.

That view may be commonplace, but it’s not un-assailed. The issue is complicated on a global level, salary increases have a strong correlation to inflation, but unemployment, employee productivity and other factors also play significant roles. In some countries, pay increases are much higher than overall inflation, while in others pay increases are actually behind inflation, resulting in real wages declining; this has been a recent intentional state policy in some countries such as Greece and Spain designed to make the workforce more price competitive. However, a scan beyond the developed economies quickly reveals that inflation is far from dormant. For example, the rate of inflation in 2016 for the EMEA region excluding Western Europe is 5.6%; whilst that may not be hyperinflation, it is still significant in its effects.

But whilst inflation is still alive and kicking, recent data from the Willis Towers Watson Salary Budget Planning Report, does suggest that it may no longer be centre-stage in salary budget planning. So not gone, not forgotten, but to a certain extent de-coupled. Furthermore the regional stories behind this de-coupling are diverse.

The story in Western Europe

2010-2016 real wage increases in Europe, Middle East, Africa and Western Europe

2010-2016 real wage increases in Europe, Middle East, Africa and Western Europe

From 2012 onwards, Western Europe enjoyed a prolonged period of falling inflation, meaning that workers have enjoyed substantial real salary increases. Back in 2011, we saw salary increases and inflation strongly linked, with the former at 2.9% and the latter at 2.8%. Since then the link has loosened considerably, culminating in an inflation rate of 0.1% in 2015 and an average salary increase in Western Europe of 2.3% - i.e., a real pay increase of 2.2%. Even with a rise in the inflation rate in 2016, there will be an average real pay rise of 1.9%, a very different picture from 2011.

In the UK, the decoupling of salary increases and inflation was delayed until 2014, but the break when it came was strong: average real salary increases in 2016, for workers at all levels, reported at 2.3%.

The story in EMEA

If we look at the EMEA as a whole, the picture is slightly different to the more focused Western Europe picture. The region experienced the same decoupling as Western Europe in 2013-2014, as inflation dropped and salary increases remained at above 4.5%. However, with inflation rising in 2015 and 2016, average real-pay rises have reduced to 1.0% this year – slightly below 2012 levels.

This could be read as a re-coupling; however, given that planned salary budget increases have remained fairly constant (at 4.6% in 2015 and 4.8% in 2016 according to our data), whilst inflation has risen in two successive years, the link appears to be broken, or at the very least damaged.

Given the pressure on real pay increases caused by the rise of the inflation rate in EMEA in 2015-2016, it will be interesting to observe how companies react to this change and deal with the fact their staff will receive lower real-pay increases than in 2012-2015. Our 2016 data suggests there will be greater emphasis on increases to high performers, emerging talent and those with in-demand skills, but less emphasis on across-the-board increases for all incumbents. Without such differentiation, companies may face retention and attraction pressures, especially in high demand areas.

The story in Asia

Our 2016 Salary Budget Planning Report for Asia Pacific reveals different trends and numbers, but the decision-making for employers is no less demanding. Based on our data from 22 different markets in APAC, Salaries across Asia Pacific are projected to rise 5.9% in 2017, up a fraction from 5.8% this year but in fact reflecting broader downward pressure on salary increase budgets in the region, once average inflation for Asia Pacific of 3% is taken into account, the projected increase in real terms for 2017 will be 2.9%, down from 3.5% in 2016. 

2011-2017 Actual and projected salary increases - Asia Pacific (median)

2011-2017 Actual and projected salary increases - Asia Pacific (median)

Salaries were projected to rise 6.4% in 2016, but in reality rose just 5.8% - the first time below 6% since 2012. If that pattern continues in 2017, actual increases will be well below the 5.9% forecast by the companies surveyed. It will also mark the third year in a row that salary increase budgets have declined.

With inflation rising and real-pay increases smaller than previous, salary budgets will be stretched, and employers in APAC may need to differentiate more than previously. Following a collective rule of thumb - such as inflation plus a set percentage across the board - may no longer be feasible for company budgets nor for retaining or recruiting high-performers or staff with hot skills.

Operating in a post-inflation salary environment

There have always been attractions to using inflation rates to determine salary increases. They’re easily calculable, readily available, transparent, and relevant to employees’ lifestyles.

But the 2010’s have generated a variety of scenarios where a tight coupling of salary increases to inflation rates isn’t viable. On the one hand, we have high-inflation scenarios where real-salary increases cannot keep pace, and employers have to differentiate in how they allocate real pay increases. On the other, we have low- or zero-inflation scenarios where it’s unlikely employers will allocate salary increases of 0% or 0.1%.

In such scenarios, employers have to move beyond the easy option of inflation-linking and look at more nuanced factors such as affordability, economic growth expectations, employee performance, company performance, and market demand for talent and specific skills. Without the readiness to differentiate, or the market and internal knowledge on which to base their differentiation, companies may jeopardise retention and recruitment in core areas, and therefore their future health and performance.

They may also need to look harder at non-salary issues, from leadership and management, to training and skills development. Like competition for talent and market rates, these factors are not new; it’s just that they may play a greater role in employers’ salary budget planning than previously. To be sure, inflation’s not dead, but in salary planning it may have been relegated to a bit part.