How German pay rises could save Europe

Germany wagesREUTERS/Darren StaplesGermany’s players lift the World Cup trophy as they celebrate their 2014 World Cup final win against Argentina at the Maracana stadium in Rio de Janeiro July 13, 2014.

Germany is getting a pay rise. And this is great news for Europe.

That, at least, is the argument in the latest note from analysts at ABN-Amro. They point out that wage growth in Germany is already well above the eurozone average, with incomes per hour worked rising by 1% quarter-on-quarter in the last three months of 2014.

German unemployment has hit historically low levels not seen since the 1980s meaning competition for workers is helping to drive up wages. Negotiated salaries are now rising at the fastest pace in two decades:

The figures suggest German wages are running substantially ahead of the eurozone’s average of 1.3% year-on-year and that gap is only likely to grow. This is important because higher wages mean that workers can afford to spend more, providing a boost to the economy. Even more significantly from a European perspective, it might also mean that German demand for imports from struggling Southern European countries also increases helping to reduce the region’s gaping economic imbalances.

Indeed the entire story of the German economic miracle and Southern Europe’s decline over the past few years cannot be understood without reference to what’s happened to wages.

Although Germany has been seen as a powerhouse economy over recent years, driving forward even as many of its eurozone peers were falling away, in the late 1990s and the early 2000s the country was frequently referred to as “the sick man of Europe”. Growth averaged a meagre 1.2% between 1998 and 2005, while unemployment climbed into double figures over the period. In short, if you were to grade its performance Germany might have got a ‘C’ at best.

One of its major successes over this period, however, was the implementation of a co-determination model of corporate governance. The basic idea is to allow workers to participate in the management of the companies that they work for. To provide a tangible example, one-third of board members at German companies with between 500 and 2000 staff are employee representatives.

This model of cooperation extended to relations between the state and major labour unions. As an LSE paper from 2009 describes:

The metalworking sector (IG Metall in Germany and GMT in Austria), leads negotiations, setting wage increases equal to the increase in the national aggregate labour productivity rate. All other sectoral unions then shadow these increases, using them as a target, but rarely reaching them unless their sectoral productivity levels permit it.

And here’s what this has meant in practice — German wages failed to track productivity gains as closely as its peers. That is, it became more competitive by holding down wages even as workers were producing more output at lower costs.

This dynamic gave a big boost to German industry competitiveness, and in particular to the country’s export industry at the cost of its competitors both outside of Europe but also within the monetary union. As an AEA paper from last year put it (emphasis added):

Germany’s gains in competitiveness with regard to France, Italy, and Spain cannot be due to gains in competitiveness with regard to France, Italy, and Spain cannot be due to currency depreciation (and in fact the euro appreciated relative to the currency of most trading partners), because these countries all share the euro, and so it must have arisen because German wages grew at a slower pace than productivity relative to these other eurozone countries.

Much of this wage restraint reflected the enormous cost of reunifying West and East Germany. Conservative estimates suggests that in the decade from 1993-2003 West Germany spent around €900 billion in net transfers, or around 50% of one year of GDP over that period. Integration on this scale represented a huge burden on the German state, but it also came with both an influx of new, low cost workers from the former Communist east and opportunities to expand supply chains eastwards as well.

This left German unions unable and unwilling (for patriotic reasons) to bargain for significantly higher wages over that period. Moreover, as Frances Coppola hints at in her latest post, the influx of this cheap labour from the east both helped those countries that were able to take advantage of them but structurally impaired those that could not (such as Greece).

The result is what we see above. Germany underwent a period of painful adjustment in order to pay for reunification, but has emerged stronger and more competitive than many of its European peers. Which is fine in a world of flexible exchange rates, where countries can adjust their competitiveness through a weakening or strengthening of their currencies relative to their trading partners.

Of course, those within Europe’s single currency had no such pressure valve. Instead Southern Europe has relied on so-called “internal devaluation” whereby wages are forced downwards through spending cuts and unemployment pushed the other way. All of this while German workers were still not getting the rewards in their wage packets that their improved productivity so richly deserved.

The pressure of this has finally begun to take its toll, it seems. Again from the LSE paper:

After pursuing a policy of high wage moderation for nearly ten years, with little to show for it in private consumption growth, Germany’s pilots (VC), hospital doctors (Marburger Bund — MB) and train drivers unions (Deutsche Lokfurher — GDL) exited Germany’s main union federation, the DGB, and with it the pattern bargaining wage coordination system in order to negotiate higher wage increases. Growing wage militancy from ver.di, DGB’s large white-collar services sector union (of whom MB and GDL used to belong), suggests that these three cases of union decoupling may not be exceptions to the rule, and further de-couplings could be looming on the horizon.

The risk of fractures within the German union system has clearly prompted action. Germany’s largest trade union, IG Metall, struck a deal for a 3.4% pay rise starting from April (after having asked for 5.5%) indicating both the increased bargaining position of German workers and the growing willingness of its unions to push to higher settlements.

If this is replicated across the country’s labour market it would be welcome news not only for German workers but for countries across the eurozone. Three cheers for German workers!

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