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(Bloomberg) — Belgium’s almost unique wage-hike system is being put to the test as spiraling inflation pushes the country’s salaries above its neighbors, threatening its competitiveness. 

The sixth-largest euro-area economy may see public and private wage costs jump as much as an unprecedented 12% over the next two years, as forecast by the National Bank of Belgium, driven by inflation that has surged to a near 40-year high. This is a strain for a country that relies on exports for four-fifths of its gross domestic product.

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The Belgian system is unusual because it extends well beyond the public sector to include most private employers. 

While other European countries have moved away from such rules, many are now facing growing pressure from unions and workers to raise salaries amid spiking prices. But economists warn that those higher wages could ultimately lead to job losses and bankruptcies.

Belgium’s current government has ruled out any changes to the mechanism, which was introduced in the 1920s, even though international institutions including the European Central Bank and the Organization for Economic Co-operation and Development have criticized it for potentially contributing to a wage-price spiral, where inflation is further fueled by increasing wages. 

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ECB officials meeting last October recalled how stagflation in the 1970s occurred in an environment in which “indexation allowed wages to react to energy prices and thus sustained both stagnation and inflation.”

Voices are also getting louder at home, as business groups and entrepreneurs call for the government to reform the system.

“The energy crisis and the war in Ukraine are pushing inflation to unprecedented levels of 10%, and we are losing competitiveness, at a very fast rate, threatening jobs and income,” Pieter Timmermans, CEO of the Federation of Enterprises in Belgium, which represents more than 50,000 companies, said in an emailed statement. “The oh-so pernicious wage-price spiral is in full swing.”

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6% Raise

Indeed, the automatic indexation mechanism based on the so-called health index — which excludes alcohol, tobacco and petrol — is expected to increase public and private wages and social benefits by around 6% in 2022, the OECD said in a June report. 

Consumer prices, which surged above 9% in June in Belgium mainly due to energy bills and stayed above that level last month, triggered a 2% automatic indexation for public workers, the fifth such move over the past 11 months. Wage indexation for the private sector takes place at different times throughout the year, depending on the sector.

The various increases are boosting Belgium’s wage gap with neighboring Germany, France and the Netherlands by about 5%. The forecast for the three countries is considered in the legal framework guiding wage negotiations in Belgium.

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“At the international level, rising wage costs in addition to other costs increases will harm our competitiveness and share of the market,” said the Belgian enterprises federation, which has been pushing for consultations with the government and trade unions. “The growing pay gap with other countries will also make our country less attractive to foreign investment and will lead to new relocations.”

More than half of the sectors in Belgium expect a worse economic climate, compared to 42% in November, the federation of enterprises said in its report last month. The group suggests following the example of Luxembourg by temporarily limiting the automatic indexation until neighboring countries make decisions on wage hikes. 

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Prior Suspensions

Belgium’s mechanism, which was developed after World War I to address demands for higher wages, has been suspended in the late 1970s and early 1980s, and most recently for a year starting in April 2015 to close a wage gap that had accumulated with its neighbors since 1996. 

More than 90% of 350 employers say that “something” needs to be done to lower the impact of labor cost inflation, including postponing or abolishing a part of the indexation, according to a June survey by Unizo, an association of more than 100,000 Flemish small and medium-sized businesses. Two-thirds of companies said they have or will pass the cost on to the consumers through higher prices, a third plan to cancel or postpone investments, and 27% will delay hiring new employees.

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In most euro-area countries, public wages aren’t automatically indexed to inflation, nor does it play a formal role in wage setting. A number of countries abolished indexation in the 1980s, including Denmark, France and Italy.

Luxembourg is the only other nation among 19 euro-area countries that has a full automatic wage indexation based on the six-month moving average of the National Index of Consumer Prices. Following a 2.5% indexation in April, a second tranche which should have been triggered in July was postponed. 

Ahead of a possible further wage rise in the fourth quarter, Luxembourg’s Chamber of Commerce has opposed automatic increases, while Prime Minister Xavier Bettel expects to hold tripartite consultations with business associations and trade unions after new calculations are made in September. Cyprus and Malta also have a restricted form of indexation.

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In Germany, Europe’s biggest economy, wages are negotiated between employers and unions or individual employees taking into account macroeconomic environment and overall wage development in other major sectors. 

In Spain, workers suggested a compromise, acknowledging it would be impossible to ask for a wage increase in line with inflation and seeking gradual adjustments instead.

Belgian ‘Symbol’

As long as the socialist party is in the Belgian government, there will be no change in this mechanism because it has proven efficient to protect workers against negative effects, Thomas Dermine, state secretary for economic recovery and strategic investments, told Bloomberg recently. 

“It’s a symbol of Belgium,” he said. “The thing is that you waste a lot of time in negotiation between the employers and the unions. For us, it happens in the automated way. It would be a be a very bad signal if you started to discuss this kind of thing especially in the current inflation environment we have.”

Charlotte de Montpellier, a senior economist at ING Economic Research, said in an interview that Belgium’s indexation has become critical in preventing big protests or strife with unions over wages, but that it’s unsustainable economically.

“I would say maybe Belgium cannot afford it but there is no willingness to change it,” she said. “They are just hoping it will be ok at least for now and if there is anything to change, to adjust it will be after the current difficult time, the current shock.”