What is behind low wages in central and eastern Europe?

This paper compares wages across Europe in relation to the characteristics of workers and firms, with a particular focus on wage levels in central and eastern European countries. Worker and workplace endowments can be taken as a proxy for labour productivity. We estimate the extent to which wage differences observed at an aggregate level can be related to the different compositions of workforces and workplaces, as well as the types of jobs conducted in separate countries. We also decompose the observed differences in returns on endowments by identifying the sectors and occupational categories that contribute most to the wage gaps observed at the aggregate level. The wage gaps in low-wage countries actually appear larger once differences in worker, work and workplace characteristics are controlled for. In contrast, the differences in wages between high-wage countries diminish when we control for these endowments. The wage gap between East and West thus seems to be explained by a much lower return on skills and other characteristics rather than by differences in the composition of workforces and firms. Sectoral and occupational analysis suggests that central and eastern European countries have developed a generalised low-cost and low-wage model, with relative returns particularly low on higher skills. There is much less wage disparity across European countries in more labour intensive and lower-paid services sectors, such as accommodation and food service activities. The magnitude of the wage gap seems to be driven by the relative position of sectors and occupations in high-wage countries.