Economics and politics - comment and analysis
17. June 2020 I Heiner Flassbeck - Friederike Spiecker I Economic Policy, Europe, General Politics, Labour Market and Distribution of Income

The Reward for Wage-Cuts is Disaster

There is no return to pre-crisis normality. The new lessons must be learned quickly, otherwise an economic catastrophe is imminent. The course must now be set correctly, especially with regard to debts and wages.

Cross-posted from Makroskop and Brave New Europe

Translated by BRAVE NEW EUROPE

Everyone wants to return to normality – economically as well. However, most people do not want to admit this yet: the normality before the crisis will no longer exist. The economy after the crisis will no longer be the economy we knew before. It has turned out quite different from what the politicians and probably also the virologists and epidemiologists had imagined. Operation “grandes vacances”, after which the world was simply supposed to return to the old familiar life after three or four months, failed magnificently.

Let’s now revisit the reasons for the failure. What matters now is to avoid making serious new mistakes that could damage economic development in Germany and throughout Europe for decades to come. A pattern that leads to completely wrong decisions is already looming. Just as after the financial crisis of 2008/2009, the coalition partners in Berlin are overtaken by panic fear of their own courage. After successfully combating the financial crisis with public debt at the time, the debt brake was written into the constitution at breakneck speed and the goal of a black zero was pursued for years – to the detriment not only of the German economy but also of euro-zone partners.

Repay public debt quickly?

The first voices are already being raised in the CDU calling for tight schedules for the repayment of public debt. Paul Ziemiak, the CDU secretary general, speaks of ten years in which all public debt, which is now being added to, is to be completely repaid. He justifies this demand with the fact that the previous policy of black zero is now paying off in the crisis, because Germany has “acquired” leeway “for which other states envy us today”.

The macroeconomic cluelessness betrayed by these words certainly fits seamlessly with the expectations of potential CDU voters, which makes this position understandable from a party political point of view. Unfortunately, this does not change their lack of macroeconomic logic. Throughout the governing coalition, people are talking about debt reduction as if it were only a question of political will whether or not they can manage it.

But this is far from the case. As explained here, for example, in times of a thrifty corporate sector, it is simply impossible for the state in a large economy to wait for a growing economy, which is needed to bring the budget deficit down to zero and repay government debt. It is time to take note of the facts: There is no longer a corporate sector that invests so much that it has to go into debt.

In Europe as a whole, it is impossible to reduce public budget deficits or even to repay old debts. Private households have traditionally been saving, and the corporate sector has been doing the same for about 20 years. However, saving must necessarily be accompanied by debt if the economy is not to shrink at the same time. Anyone who ignores this macroeconomic logic and tries to take economic policy measures that explicitly violate it will achieve the opposite of what is desired: it would provoke a deepening and prolongation of the crisis to the detriment of large sections of the European population.

To hope for the non-European countries to become the main debtors is extremely risky. Whoever takes this path risks a trade war between Europe and the rest of the world or a devaluation race between the euro and the non-European currencies (which is practically the same thing). Both scenarios would lead the world even deeper into economic crisis. Because Europe will never have the opportunity to shift the burden of debt to the outside world, i.e. to restructure itself through current account surpluses, it is ludicrous to want to implement such a strategy, which runs counter to all logic, the guiding principle of economic policy for the next ten years.

Germany, too, cannot repeat its current account surplus strategy of the last twenty years at the expense of its euro-zone partners. This will not succeed because the economies of the euro-zone partners are now on the brink of collapse. The first halfway realistic professional forecast for the year 2020, which was presented by the DIW last week, concludes that the German current account surplus will fall to 80 billion euros this year (compared with 200 billion euros in 2019).

Without destroying Europe completely, there is no possibility for Germany to return to the old situation with a high current account surplus. A renewed attempt by the German economy to undercut its European trading partners through relative wage cuts would be suicidal. Not only would this again cause massive damage to German domestic demand, it would also push its European partners, who are desperately fighting for economic survival, over the cliff.

Wage sacrifice is suicide

But precisely this suicidal variant is already in evidence – in addition to the politicians’ desire to reduce the public deficit again and even turn it into surpluses to reduce debt. Not only is there virtually nothing heard from the German trade unions apart from the demand for job security, but there are already areas in which there is open talk of employees suffering a reduction in wages in return for job guarantees from employers. The case of Lufthansa is of course spectacular, where pilots have offered to temporarily waive 45 percent of their salary in order to help the airline through the crisis.

But even the huge sacrifice made by the pilots cannot save all their jobs if business flying is replaced to a large extent by video conferencing and other virtual means of communication and cooperation. Perhaps the corona shock was not the real cause of the crisis in aviation, but it could be the trigger and accelerator of a profound structural change in the globalised economy that cannot and should not be prevented by salary sacrifice. The famous stoker on the electric locomotive does not make sense even if he travels for half his former salary.

But one thing is absolutely clear: for the employees as a whole, wage and salary sacrifice is not a game of vabanque as it is for the pilots, but suicide by instalments. The eloquent silence of the trade unions gives rise to fear that this is exactly what will happen. Wage restraint, i.e. allowing German wages next year to rise by much less than the warranted three percent, will lead in the short and medium term to a weakening of economic development and thus to the destruction of jobs and in the longer term to deflation.

Where do the German trade unions still want to go? The chart shows that the collective bargaining agreements of the past ten years were already very close to the target inflation rate of 1.9 percent, i.e. effective real wages rose only slightly or not at all. Anyone who falls below that level or does not raise wages at all will create competitive pressure for the whole of Europe, which can only end in Europe-wide deflation.


In the transition phase, i.e. until price developments fully react to falling wages, weaker increases or even decreases in real wages due to weaker demand from workers mean that jobs are lost. If, at some point, the price trend then equals wages, so that real wages remain constant, the wage-induced weakness in demand by employees will be replaced by a price-induced reluctance to buy (“tomorrow it will be even cheaper”). Together with the planning-uncertainty for every business calculation, this will finally paralyse investment demand.

What looks like a barter deal “wage concessions in exchange for job security” at the company level is a job destruction programme at the macroeconomic level. Which means that despite the crisis and the general economic weakness, every effort must be made to keep collective wage increases at a minimum of three percent.

What must the state do?

The state is directly responsible for the fact that job security is the most important thing for the trade unions today. As a result of the Hartz legislation introduced by the Red-Green coalition at the beginning of this century, the economic and thus social decline of an ordinary worker who becomes unemployed is enormous. After only one year of unemployment, he is at the level of the poorest in society, namely Hartz IV.

The crash for the long-term unemployed, which was pre-programmed by the state through the Hartz legislation, has led to a considerable drop in the willingness of union members to strike for reasonable wage agreements. The risk of losing their social status when they lose their jobs is so great that any threat by employers to close production plants and cause workers to migrate is intercepted and leads to concessions in wage negotiations. This legislation, which is explicitly based on the idea that the unemployed should be encouraged to make a greater effort to find existing jobs, was already more than questionable when it was introduced. Today it is extremely dangerous.

Those who become unemployed now lose their jobs because the state has forbidden them to continue working or has otherwise prevented or at least made it more difficult for their companies to produce. Threatening these people with a crash to Hartz IV status is antisocial, unfair and macro-economically destabilising. The state, which is directly responsible for the job losses, has a duty – for moral as well as purely rational macroeconomic reasons – to ensure immediately that generous rules are introduced in the event of unemployment. An age-independent guarantee of 70 to 80 percent of previous income over the next two years would be a measure that would calm many minds and enable the trade unions to do what is now economically necessary.

Whether we support it or not, we will not be able to avoid far-reaching structural change in the economy. We can, however, control whether many people, and especially the economically and socially weaker ones, will fall by the wayside or whether there will be fair chances for everyone to overcome the crisis quickly. If the state accompanies the structural change with strong unemployment insurance (and fair protection for those who are not entitled to unemployment benefit), all those who first become unemployed and therefore have to change jobs and retrain can get involved in the changes relatively fearlessly.

If, on the other hand, the state keeps the present framework of unemployment insurance and basic security and concentrates primarily on preserving old structures on the capital side (see Lufthansa) or on promoting investment in new structures from an ecological point of view, it cannot avoid the accusation that it is putting the interests of investors above those of the working population. The belief that all economic prosperity in the long run comes primarily from companies was already one-sided in the days when the corporate sector was still in debt and thus took on the macroeconomic task expected of it. Today it is clearly wrong.