Lithuania’s economic situation is one of the best in Europe, but labour shortage and inflation challenges arise
Lithuania’s economic growth is one of the fastest in Europe. However, new challenges are becoming evident: the number of companies indicating that labour shortage limits their business expansion is rising, while higher inflation will persist longer than projected previously.
“Resolute and coordinated monetary and fiscal policy stimulus helped our country avoid serious economic problems due to the pandemic. As euro area economic recovery is lagging and uncertainty concerning the new variants of the virus persists, the overall monetary policy remains accommodative. The period of growth is the right time to prepare fiscal measures that would prevent our economy from overheating. First of all, it is necessary to increase budget revenue in the coming years and thus reduce deficit faster than currently planned,” says Gediminas Šimkus, Chairman of the Board of the Bank of Lithuania.
Lithuania’s economic situation during the pandemic was significantly better than considered up to now. According to the revised data of Statistics Lithuania, last year the country avoided a recession, although previous calculations indicated a decline of the gross domestic product (GDP) of 0.8%. According to the revised projections of the Bank of Lithuania experts, the GDP will grow by 5.1% this year and by 3.6% next year.
On the basis of the revised data, the Bank of Lithuania updated its assessment of the economic situation: economic activity in 2020 was almost equal to its potential level, i.e. operation under normal circumstances, however, it will exceed this level significantly in 2021 and 2022. This means that the economic temperature is higher than considered previously.
Higher economic activity is starting to pose challenges in the labour market, as the number of companies indicating labour shortage as a factor limiting their activities is rising. For example, according to the November survey data, 42% of construction companies stated they are facing labour shortages. This percentage is twice higher than a year ago. The labour shortage problem becomes more acute also in other largest economic sectors: industry, retail trade and services. Currently, there are 27 thousand job vacancies in Lithuania, as much as 1.5 times more than a year ago. Rising competition for employees was one of the most important factors determining the annual growth of wages in Lithuania of around 10%. By now, the rapidly growing wages have not reduced competitiveness of Lithuanian businesses abroad, while wages in Lithuania still lag behind the EU average more than productivity does (by –35% and –29% respectively). It is projected that wages will continue to rise: next year their growth will reach 8.2%.
Although fast wage growth significantly contributed to the rise in the prices of services, a larger part of inflation is driven by factors that are not related to Lithuania’s domestic market, such as a significant rise in the prices of energy resources and other raw materials as well as supply chain bottlenecks. It is projected that average annual inflation in Lithuania will stand at 4.5% this year, mainly driven by the rise in the prices of energy products and industrial goods. Next year, inflation will remain elevated and stand at 5.1%, i.e. it will be almost twice higher than projected previously. It is projected that annual inflation will decline with the drop in the demand for gas after the heating season, i.e. around mid-2022.
According to Gediminas Šimkus, inflation in Lithuania is partly determined by factors common to the entire euro area. The single monetary policy pursued to contain euro area inflation is also implemented by the Bank of Lithuania. The latest projections indicate that inflation in the euro area will approach the European Central Bank’s price stability objective of 2% in the medium term. The part of inflation related to domestic factors as well as the temperature of the economy could be cooled down by fiscal measures, by avoiding additional stimulation of domestic demand and thus preventing the acceleration of price growth. This could be achieved in two ways: if budget revenues were increased faster or expenditure was growing slower than planned. It would not be useful to limit the growth of public spending more strictly, as it is already too low in terms of Lithuania’s development level and GDP. This drives many structural problems, such as insufficient funding of education, health care and social security systems. Therefore, it would be more rational to focus on budget revenues and seek to increase them by reducing the shadow economy and the related insufficient collection of taxes, especially the value added tax, more resolutely solving the persistent problem of unequal taxing of different forms of business and expanding property and environmental tax base.
The latest comprehensive economic projections are available on the Bank of Lithuania website.