Labour force riddle. CEE REAL ESTATE July Macro Outlook report. The problem. The solutions

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1 Macro Outlook report CEE REAL ESTATE July 2018 Labour force riddle The problem The availability of workers to companies is right now perhaps the most significant factor when assessing business plans and prospects in the CEE-6 region. Very low unemployment, dynamic growth, emigration and the fast development of the service sector have combined to create acute labour shortages. If the labour force riddle is not solved, then we foresee limitations to GDP growth, perhaps a recession and a likely shadow over private investment in the region in the medium to long run. If fulfilled, this path has negative implications for the demand for commercial real estate in CEE into the next cycle. The solutions We outline in this report six possible solutions to the riddle: the first is a return of the labour force from the west. We reported on the possibility of workers returning to the CEE-6 countries on a net basis in our Labour force boomerang report published in July Our data gathering suggests another 0.5mn CEE6 passport-holders migrated west in the calendar year The boomerang is not with us yet but the economic conditions to trigger it, including wage growth in CEE, are. Secondly, immigration from the east, from the former USSR and elsewhere, for similar economic reasons can boost the CEE-6 workforces. It appears that there are c.2mn Ukrainians in Poland already, a figure which may be rising rapidly. These two appear the most likely solutions for now. We see, thirdly, a step up in the quality of labour supplied in the region, through better education and training to improve productivity. If workers are more productive, then the labour shortages are felt less. Boosting graduate numbers should help. But do the graduates have the right skills? Can workers be more productive? On top of that, fourthly, an increase in the working activity rate in the population aged and perhaps those of retirement age has boosted workforce sizes across the EU and CEE-6 over the last 15 years. This can continue in the future with more infrastructure investment and correct legislation. CEE-6 s recent high wage growth can sustain and be a factor in these four scenarios. Less positively for the workforces, downward shifts in the demand for labour are possible. In the long run, fifthly, an automation of jobs and lower working hours in the week may do the job. These shifts, allied to technological changes, are already in train. And sixthly, on a less optimistic note for real estate, if nothing of note is done then an economic slowdown or a recession is most likely to solve the riddle by itself in the shorter term.

2 The riddle Jobs, growth but no people Very low unemployment, dynamic growth, emigration and the fast development of the service sector are combining to create acute labour shortages in CEE. If the labour force riddle is not solved, then we foresee limitations to GDP growth and a likely shadow over private investment in the region in the medium to long run. Unemployment rates in all the CEE-6 countries are presently at the lowest point seen in this cycle and all are below the EU-28 s (Eurostat methodology) 7.0%. Czechia remains with the lowest level in the EU, at just 2.3%. The riddle exists in part because typically when economies reach such cyclically-low levels of unemployment, the historical precedent is for an economic slowdown/recession to ensue. That slowdown sees jobs lost, the unemployment rate rising and thus some equilibrium to the labour supply is restored. This mechanism involves economic pain, which is not attractive to policymakers, business or real estate players alike. Symptoms and part of the process of a cyclical overheating and eventual economic pain include rampant wage growth and a feedthrough to inflation rates. We predict national wage growth in a 4%-10% range for the CEE-6 countries in 2018, compared to the wider range of 6.6% (Slovakia) to 14% (Romania) recorded in the region last year. Consumer price inflation ( CPI ), has risen to hit 5.4% yoy according to the latest June reading for Romania but remains below 3% in all of its peers. So, inflation is not signalling the risk of recession yet outside of Romania but with wage rises continuing, it would be no surprise to see CPI tick higher in CEE-6. Another portent is the rising ratio of job vacancies compared to the number of unemployed. In Czechia, the number of vacancies exceeded the unemployment count by a factor of 1.78x at the end of Q (Eurostat data). Job vacancies in the Czech economy have increased even more since March. Vacancy to unemployed ratios at these levels is a rare development in any economy. The numbers are by no means as severe in the other CEE countries but nevertheless at cyclical highs everywhere. Other evidence of the labour market tightness comes from qualitative surveys. Every quarter, national data agencies ask identical questions of samples of industrial and service sector companies across Europe. One that is asked is whether the company faces a labour shortage that is acute enough to arrest plans to expand output. The survey data for Hungarian industrial companies has been at a staggering 70%-90% yes response rate for several quarters already. But it is very noticeable that across the CEE-6 (and across the EU as well) these quarterly survey points are rising inexorably. The other part of the labour market riddle in CEE-6 is that rampant wage growth is occurring in some sectors yet is not resulting in significant job losses through companies relocating out of the region, or re-shoring back west or east to Asia. The wage gap between the CEE-6 and the rest of the EU remains vast and how much that gap closes will dictate in part how the labour force puzzle is solved. Fig. 1: Rates of unemployment in CEE and key EU countries (%, May 2018*) Spain 15.8% Italy 10.7% France 9.2% EU % Slovakia 6.8% Bulgaria 5.0% Romania 4.6% UK 4.1% Poland 3.8% Hungary 3.7% Germany 3.4% Czechia 2.3% * April 2018 figure for Hungary Fig. 2: Numbers of unemployed and job vacancies in CEE-6 countries in March 2018 (in 000) 231 CZ Job vacancies PL Unemployment (Eurostat) 709 SK HU Fig. 3: % of industrial and service sector companies agreeing that labour shortages are arresting growth of output EU UK France Germany Bulgaria Romania Slovakia Hungary Czechia Poland RO BG Industrial Sector Service Sector 80% 60% 40% 20% 0% 20% 40% 60% 80% 2 Macro / Outlook report JULY 2018 CEE

3 Fig. 4a: Size and breakdown of CEE populations in Western European countries in 2017 [2016] ICELAND 0.02mn [0.01mn] Total of CEE-6 born residents in W Europe was 7.53mn on 1 Jan 2017 FINLAND NORWAY 0.13mn [0.13mn] SWEDEN 0.15mn [0.14mn] 0.01mn [0.01mn] IRELAND 0.15mn [0.15mn] LUXEMBOURG 0.01mn [0.01 mn] UK 1.57mn [1.36mn] NETHERLANDS FRANCE 0.28mn [0.25mn] 0.19mn [0.17mn] BELGIUM 0.2mn [0.19mn] DENMARK 0.08mn [0.08mn] GERMANY SWITZERLAND 0.12mn [0.12mn] 2.02mn [1.65mn] CZECH REP POLAND SLOVAKIA AUSTRIA HUNGARY 0.36mn [0.34mn] ROMANIA PORTUGAL 0.04mn [0.04mn] SPAIN 0.82mn [0.82mn] ITALY 1.24mn [1.23mn] GREECE 0.14mn [0.14mn] BULGARIA Fig 4b: Breakdown of CEE-6-born residents in Western European countries Belgium Denmark Germany Ireland Greece Spain France Italy Luxembourg Netherlands Austria Portugal Finland Sweden United Kingdom Iceland Norway Switzerland Poland Czech Rep. Hungary Slovakia Romania Bulgaria 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% Source: Eurostat data 2017 population estimates of EU states by country of birth, except for Destatis.de for Germany, Sefstat for Portugal and World Bank for CZ/SVK/HUNG in Spain. 3 Macro / Outlook report JULY 2018 CEE

4 The solutions A labour force boomerang We set out in our July 2017 research Labour force boomerang the argument that the now 7.5mn-strong emigration of CEE-6 passport-holders to Western Europe may reverse. We believe that both economic and emotional/social factors are shifting such that the tide of migration turns. The wide gap between average wages in the CEE-6 and those in Western Europe remain a key competitive advantage. Companies appear still willing to tolerate wage rises and maintain jobs in the region even the face of a loss of competitiveness. If annual average wage rises in the 5%-10% range continue, the economic argument for a worker to work in their native country becomes louder. Well-run national budgets allow the CEE-6 to retain low tax regimes. If the numbers for the workers add up, then the more emotional and individual judgment of whether to stay or return comes into play. There will still be emigration from the region but, we calculate that by 2021 some 411,800, on a net basis, of the emigrants may have returned. This compares to 569,000 job vacancies in the CEE-6 at the end of March Immigration from CIS and S Europe Setting aside the politics of migration and challenging the net emigration pattern of the last 200 years, the presence of foreigners is noticeable in the CEE-6 for the first time. 7.1% of Czechia s population in 2017 was foreign, according to the World Bank migration dataset. The lowest ratio was Poland s, 1.8%, including the World Bank s estimate of 221,307 Ukrainians. The truth appears to be a multiple of that figure. Several sources suggest 2mn Ukrainians in Poland at the end of ,000 work permits were issued to Ukrainians last year (National Bank of Poland). Media such as money.pl suggest that the number may reach 3mn by the end of Ukrainians are helping to drive Poland s economic performance and solve its demographic and labour riddle. Are there more CIS citizens to come? Yes, if wages in the CEE-6 keep rising. The comparatively good quality of life on offer is an attractive proposition. And the EU relaxed the visa rules for Ukrainians in June Czechia doubled the quota of Ukrainians allowed in on work permits to 19,600 in January The Czech Deputy Minister of Labour stated in Q that 300,000 Ukrainians had applied to work there. We estimate there are over 150,000 Ukrainians in Czechia presently. And other CIS countries are sources as well: 121,717 Russians and 92,276 Belarussians are in the CEE-6 (World Bank). Immigrants from these sources have the advantage of an easier integration into a Slavic milieu in Poland, Czechia, Slovakia and Bulgaria. Moldovans (151,249 (World Bank), perhaps over 0.5mn in our estimation) have a good chance of integrating into Romania. Hungary has the least ability in the CEE-6 to tap into a hinterland of potential immigrants who could integrate easily into society. An even more recent phenomenon is a so-far small flow of mainly young immigrants from those parts of Western Europe with high unemployment, such as Spain and Italy. Most of these migrants and those from the CIS are workers, addressing the labour shortage. Fig. 5: unit labour costs across EU (2017, EUR/hour) BULG 4.9 ROM 6.3 LITH 8.0 LAT 8.1 HUNG 9.1 POL 9.4 CRO 10.6 SVK 11.1 CZ 11.3 EST 11.7 MALT 13.8 PORT 14.1 GRE 14.5 CYP 16.0 SLV 17.0 ESP 21.2 UK 25.7 EU ITA 28.2 Eurozone 30.3 IRE 31.0 FIN 32.7 DEU 34.1 AUT 34.1 NETH 34.8 FRA 36.0 LUX 37.6 SWE 38.3 BEL 39.6 DEN Tab. 1: the Boomerang personal P&L Tangible profit & loss account Revenues / income Costs / living expenses Currency effect / interest costs Incentives Taxes Intangible emotional factors Overcrowding Language Social status Physical environment Political environment Status Tab. 2: Possible return rates to CEE by 2021 PL CZ SK HU RO BG % of pop. In W Europe in % 2.0% 4.9% 4.6% 15.7% 11.2% % of migrants Boomerang-ed back by 2021 % of overall population returning by 2021 Absolute numbers in W Europe in 2017 (million) Absolute numbers returning by 2021 (thousand) Wages rising faster in CEE than in W Europe Inflation rates similar in W Europe to CEE UK Pound Sterling down and koruna up in CZ. Higher interest costs and informal lending for migrants in W Europe? No big gov t incentives to move back to CEE yet Lower tax rates in CEE-6 than W Europe. Less hidden taxes? Status Low quality urban living for many migrants to W Europe Opportunity to live/raise family in native language environment Bigger opportunity to contribute to native society rather than be a peripheral migrant Pollution/noise/congestion in big W European urban centres now as bad as in CEE-6? Was worse in CEE and maybe still so. But West may be less welcoming in future? 7% 15% 7% 10% 3% 4% 0.50% 0.30% 0.34% 0.46% 0.47% 0.45% ,400 31,500 17,500 48,000 92,400 32,000 4 Macro / Outlook report JULY 2018 CEE

5 Fig.6: Immigrant stock in CEE-6 countries in 2017 (World Bank dataset) PL 1.8%* 2,000,000** CZ 7.1%* 150,000+** 3.4%* 16,102** SK HU *% of country s population from other countries (World Bank, 2017 estimates) 5.0%* 50,000+** **Number of Ukrainians estimated by media/colliers International as resident (end 2017) Data on origin of other nationalities (in doughnut charts): Bulgaria Czech Republic Hungary Poland Romania Slovak Republic Russia 30,950 35,700 4,053 40,879 7,280 2,855 Belarus 1,064 9, , RO BG 2.0%* 16,000** 2.2%* 10,000** Ukraine 9, ,000 50, ,307 15,698 10,450 Moldova 3,162 10, , Other CIS 9,333 20,485 1,622 8, China 1,471 5,219 18,193 1,262 4,909 1,135 Turkey 9,867 3,000 2, , Other CEE 20, , ,551 74,089 38, ,804 W Europe 43,122 54,846 77, , ,596 26,706 Rest of world 24, ,466 66,532 53,146 39,887 13,389 Russia Belarus Ukraine Moldova Other CIS China Turkey Other CEE W Europe Rest of world 5 Macro / Outlook report JULY 2018 CEE

6 Improving labour quality When labour is scarce, growth and efficiency can result from the labour force delivering higher productivity. That higher productivity becomes a substitute for extra workers. Switching workers out of public-sector jobs may be an option in Hungary and Slovakia especially, as both of those countries have a higher proportion of their workforces in public administration roles. On-the-job training can make a lot of difference but the baseline for improving long-run productivity across an economy is education. Only Poland has a (marginally) higher % of its workforce with a tertiary level of education vs. EU-28 according to our calculations of 2017 Eurostat data (Fig.8) The CEE-6 have amongst the lowest ratios in the EU and the smallest percentage point increases since 2002 (Fig.8). But considering the low base of comparison in 2002 (Fig.9), the rise in the tertiary workforce in proportion to the whole is impressive across CEE-6, especially in Poland. What the chart also shows is a positive correlation of this expansion with GDP growth across Europe. If the CEE- 6 keeps growing faster than its peers, the tertiary-educated workforce will probably also grow faster. Fig. 7: % of workforce employed in public administration, social security and defence in Q ,0% 10,0% 8,0% 6,0% 4,0% 2,0% 0,0% 6,6% 6,5% 9,6% 9,1% 5,0% 7,1% 6,9% Poland Czechia Hungary Slovakia Romania Bulgaria EU-28 average Fig. 8: % of workforce with tertiary education level and change in p.p of % between 2002 and % Y 20% 15% 10% 5% POL SLV PORT MALT AUT SWITZ LAT LUX ICE SWE GRE SVK CZ EU-28 FRA NETH ROM CRO ESP EST ITA HUNG BULG DEN DEU LITH IRE UK CYP BEL FIN NOR X Y % of workforce with a tertiary (post-school) level of education in 2017 Change in percentage points of tertiary workforce as % of total workforce % X 0% 10% 20% 30% 40% 50% 0% 10% 20% 30% 40% 50% Fig. 9: Annual growth in GDP per capita and expansion of tertiaryeducated workforce between 2002 and 2017 Y 160% 120% 80% 40% GRE UK PORT ITA LUX SWITZ EU-28 SWE FRA NETH CYP BEL ESP FIN NOR DEN DEU AUT SLV IRE ICE CRO HUNG 0% X 0.0% 2.0% 4.0% 6.0% 8.0% 10.0% MALT CZ POL EST LAT SVK BULG LITH ROM X Y Annual growth in nominal GDP per capita in EUR, Total growth of tertiary-educated workforce (% on %), Macro / Outlook report JULY 2018 CEE

7 Increasing the participation rate Both the EU-28 and the CEE-6 have seen success over the past 15 years in policies designed to increase the proportion of the population aged that is willing and available for work, or the activity rate. Czechia s ratio stood at 70% in 2002 but had risen to 75.6% by 2017, widening the gap vs. the EU average of 72.4%. Hungary saw a significant improvement, closing on the EU average. Common explanatory factors include higher wages, training (including government programmes), increased female workforce participation and rural-urban migration. As might be expected for such a tight labour market, Czechia s employment rate (labour force at work as a proportion of the population aged 15-64) is also much higher than the EU average. On this measure, Bulgaria and Slovakia have improved very significantly since 2002, reducing previously high unemployment rates. The improvements in Romania since are more gradual, though also with a reduction of unemployment. If business-friendly policies and infrastructure investments are retained, the CEE-6 countries can improve these ratios further in the coming years, thus expanding the workforce within their own populations. And combat natural population declines. Automation and lower working hours A long-run solution to tight labour markets is automation. Automation improves productivity per worker by removing workers. Tight labour markets maybe even encourage investments in automation. Whilst the CEE-6 is by no means unique in the world regarding this threat to jobs, it does have the tight labour markets and also a high proportion of GDP that is generated by manufacturing. Automation in manufacturing may be closer to actually making a difference to the demand for labour in manufacturing than in services presently. Signs of this are present in neighbouring Germany, with the agreement this year between the IG Metall union and the auto producers to move to a 28-hour working week. Where the German auto industry goes, that in CEE-6 may well follow. Lower working hours might well improve productivity, especially in value-add service industries. But it in theory also increases the supply of spare labour capacity, as more workers move to having more than one job over the coming 20 years. Recession In the shorter run, if wages go up as a result of the scarcity of labour, inflation rises. As inflation rises, central banks hike interest rates. If interest rates are higher, then economic activity slows, due to less investment in the creation of jobs and plant and less consumption of goods by people encouraged to save. If this process is too severe, a recession (negative GDP growth) ensues. People lose their jobs in a recession, wages stabilise (or sometimes fall) and some equilibrium returns to labour markets. The above is not the inevitable future for the CEE-6 economies but inflation is rising and the central banks are starting to hike interest rates. The above will solve the CEE labour force riddle if nothing else does. Fig. 10: change in activity rates in EU-28 and CEE-6 80,0% 75,0% 70,0% 65,0% 60,0% 55,0% 50,0% Fig. 11: change in employment rates in Czechia, Bulgaria, Slovakia and EU-28 75,0% 70,0% 65,0% 60,0% 55,0% 50,0% EU-28 Czechia Fig. 12: Romania s activity and employment rates vs EU-28 activity rate 75,0% 70,0% 65,0% 60,0% 55,0% 50,0% EU-28 EU-28 activity rate Bulgaria Romania employment rate Poland Hungary Czechia Slovakia Romania activity rate 7 Macro / Outlook report JULY 2018 CEE

8 2.4 billion in annual revenue 68,000 lease/ sales transactions 180 million square metres under management 103 billion transaction value 15,400 professionals and staff AUTHOR: Mark Robinson CEE Research Specialist Research BUSINESS CONTACT: Luke Dawson Managing Director & Head of Capital Markets CEE CONTRIBUTOR: Lucie Schwabova Marketing Manager CEE Colliers International Prague Slovansky Dum, Building B/C Na Prikope 859/ Prague 1 Czech Republic countries Colliers International Group Inc. (NASDAQ: CIGI) (TSX: CIGI) is top tier global real estate services and investment management company operating in 69 countries with a workforce of more than 12,000 professionals. Colliers is the fastest-growing publicly listed global real estate services and investment management company, with 2017 corporate revenues of $2.3 billion ($2.7 billion including affiliates). With an enterprising culture and significant employee ownership and control, Colliers professionals provide a full range of services to real estate occupiers, owners and investors worldwide, and through its investment management services platform, has more than $20 billion of assets under management from the world s most respected institutional real estate investors. Colliers professionals think differently, share great ideas and offer thoughtful and innovative advice to accelerate the success of its clients. Colliers has been ranked among the top 100 global outsourcing firms by the International Association of Outsourcing Professionals for 13 consecutive years, more than any other real estate services firm. Colliers is ranked the number one property manager in the world by Commercial Property Executive for two years in a row. Colliers is led by an experienced leadership team with a proven record of delivering more than 20% annualized returns for shareholders, over more than 20 years. For the latest news from Colliers, visit Colliers.com or follow us on and LinkedIn All rights reserved.