Economics and politics - comment and analysis

Wages and prices in Germany – or why Europe will not escape from deflation within the next twenty years. Part 2

I explained in the first part that there is near consensus in Germany to only modestly let wages rise because – so goes the argument – we are being confronted with low inflation and weak productivity growth. I explained that this argument is false. Where do low inflation and weak productivity come from? What really happened? Germany went already down the road of wage moderation since the mid 1990s (with brief interruptions in 1999 and 2000 because of the intervention of some within the first Red-Green government). At stake were of course nominal wages, because these are what the social partners negotiations deal with. The wage restraint was against the will of the workers. What happened was that there existed massive political interference of the federal government with the trade unions after March 1999. This certainly went at the expense of the workers. Their bargaining power immediately deteriorated further after the SPD-Green government came to power. Since the early 2000s, this government confessed it essential helplessness in dealing with economic matters. It decided to apply the standard neoclassical recipes.

In the first phase, as the figure shows (see Figure 1) major losses in real wages occurred (notice the evolution of the dashed green line below the dashed yellow line). This happened because prices did not immediately react to the decline in unit labour cost growth. As a consequence, the internal market henceforth consistently stagnated, while, on the other hand, the relative cost reduction (which is reflected in the distance between the blue and the red line – the red line indicates what should be achieved in order to meet the European inflation target) steadily increased and produced a seemingly positive effect on Germany‘s trade position.

Figure 1


(Blue line: nominal wage per hour; red line: 1.9% plus productivity growth; gray line: 1.9% plus 1.5% productivity growth; green dotted line: real wages per hour; purple dotted line: increase of productivity per hour.)

In 2008-2009, the great financial crisis erupted. This created a far bigger deflationary pressure than the one, which existed already in Germany (because of the stagnation of the internal market). The European crisis led first to declining wages and subsequently, after 2014, to a fall in commodity prices.

By that time, Germany had already secured a superior competitive position for itself. One must always keep in mind that competitive positions accumulate year after year because the difference in labour costs increase the absolute distance between the trading partners. After 2014, Germany let nominal wages rise slightly because of falling or at least only slowly rising prices. Real wages clearly rise since the beginning of 2015, while prices decline (especially at the consumer level and this is further reinforced by falling commodity prices).

That there exists a tendency within the trade unions to celebrate these developments is certainly due to the recognition of how difficult it is to advocate for significantly higher nominal wages in a situation in which unemployment markedly decreased. Why, these people ask themselves, should I not be pleased with ‚my success‘? I try to improve the purchasing power of workers and this system guarantees this result. This, however, is of course an extremely shortsighted attitude. The statement made by the IMK that rising real wages are positive because it favours the creation of jobs is in principle correct in, but in order to make this really work we first need to escape from the deflationary context that we find ourselves in.

Deflation in Germany comes in part from the deflation that currently plagues the global economy. It is, in the first instance, driven by falling prices for raw materials. This cannot be remedied by merely increasing productivity, not even if this effect would only play in the short term (the effect is called the terms-of-trade in distribution calculations). It results from the global zero-sum game (changing the relations between producers of raw materials and consumers of such materials) that cannot be kept stable and will persist for a much longer time. However, the deflation that finds its origin in Europe is even much more destructive. It is an expression of an unresolved struggle for market shares that Germany in short notice initiated, with the help of the European Monetary Union itself.

In fact, by now we should recognise on both sides of the negotiating table that the whole operation of wage restraint was pointless to the domestic economy. We did not increase real wages for some years. As a consequence, consumption decreased – Germans had less to spend – and this in turn destroyed businesses and employment within the domestic economy. What is taking place today amounts to a certain compensation (which the employers, taking a turn, immediately put back in question). Outside the country, the whole of Europe ended up struggling with deflation. Today, the German domestic market brings back a little of what has been lost in previous years.

There is absolutely no reason to celebrate whatsoever: everything was bought with deflation, which threatens to paralyze Europe for many years or even decades. Add to that the unfathomable bad economic development in Europe for which its largest creditor country, Germany, is to a large degree responsible and which is hitting Germany too.

If German nominal waged has increased consistently by four per cent over the years since the start of the European Monetary Union, the German domestic market would have grown consistently by two per cent in real terms and would now, because of the falling commodity prices, even grow faster. All that time, it would have created jobs at home and today the European Monetary Union would not be terminally ill.

On balance remain deep divisions within Europe caused by the German export boom and insane current account surpluses. These cleavages will not disappear when German nominal wages rise by only 2 or 2.5 per cent, unless other big countries such as Italy and France decide to engage into a madness that would be similar to the southern European countries and would in turn also lower their nominal wages considerably. Naturally, this is no solution. It would, without any doubt, lead to even more deflation, to a disaster within the internal market of these countries and to more unemployment, in one word, it would generate so much dysfunction that no democratic government would be able to survive.

As a result, there only remains what we have been saying all these years: as long as Germany does not give up a part of its competitiveness in order to compensate for its de facto depreciation that resulted from its wage moderation policies, no solution can be found. This can only be accomplished if German nominal wages rise much more than is the case now. Wages need to rise by 4 to 5 per cent for a full decade. That is the relevant order of magnitude here.

It is very cynical to cheer, now that Europe’s economy is being suffocated by deflation (caused by Germany domestic market successes) and to act as if small and quasi-automatic corrections of the German real wages can solve these external problems. It is understandable that employers and other parties who are eager to brag about their successes refuse to understand what is really happening. That unions and researchers that are being paid by organisations who are supposed to defend the position of workers often all too willingly fall into the same trap is unacceptable and nonsensical. Not only is it stupid, it constitutes disaster for Europe because wages rising in Germany‚ while “maintaining competitiveness” is exactly what should not have happened .

You can read in the third part what weak German productivity growth has to do with wage restraint and what should happen in this current round of wage negotiations.