German Wage Repression

Getting to the Roots of the Eurozone Crisis

By John Miller | September/October 2015

This article is from Dollars & Sense: Real World Economics, available at http://www.dollarsandsense.org

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Ben Bernanke not only supports recent German wage increases, he also thinks further wage increases for German workers are “warranted and a win-win proposition for Germany and its trade partners”?

Now that’s a jaw-dropper. Has the former head of the Federal Reserve Board—the guardian of “price stability,” which makes policy designed to keep U.S. wages in check—switched sides in the class war, now that he is retired? Hardly. Rather, it’s that catering to the demands of German high finance and other elites has been so disastrous that even the former chair of the Fed cannot deny the undeniable: unless Germany changes course and boosts workers’ wages, the euro crisis will only worsen. Let’s look more closely at just how German wage repression and currency manipulation pushed the eurozone into crisis, ignited a conflict between northern and southern eurozone countries (with Germany as the enforcer of austerity), and left Greece teetering on the edge of collapse.

From “Sick Man” to Export Bully

In 2000, Germany was widely considered “the sick man of Europe.” Through much of the previous decade, the German economy had grown more slowly than the European Union average, its manufacturing base had shrunk, and its unemployment rate had risen to near double-digits levels. Nor was Germany an export powerhouse, despite successes of German manufacturers such as Volkswagen and Siemens. Its current account (the mostly widely used and most comprehensive measure of a nation’s financial balance with the rest of the world) showed a modest deficit in 2000. Part of Germany’s problem was the rising costs of absorbing East German workers into the West German economy and its social security system. Another problem was that the value of the Deutschemark, the German currency, had appreciated with respect the value of other European currencies.

Adopting the euro as its sole currency, in January 2002, was no panacea. For the next two years, Germany’s economy continued to stagnate. But converting to the euro—whose value was more or less an average of that of the stronger and weaker former currencies of the member countries—soon did improve Germany’s competitive position internationally. German exports, no longer valued in strong deutschmarks, but in weaker euros, became cheaper to buyers in other countries. At the same time, the exports of countries that used to have weaker currencies, such as the Greek drachma and the Spanish peseta, became more expensive. That alone transformed Germany’s current account deficit into a surplus. China is widely accused of “currency manipulation,” keeping the renminbi weak to boost its exports. But few see that the eurozone—the now 19- country bloc sharing the euro as its common currency—has functioned for Germany as a built-in currency manipulation system. And much like China, Germany used a lethal combination of wage repression and an undervalued currency to boost its exports and output at the expense of its trading partners.

Following the adoption of the euro, Germany instituted a set of “labor- market flexibility” policies intended to further improve its international competitiveness. Known as the “Agenda 2010 Reforms,” the new policies reduced pensions, cut medical benefits, and slashed the duration of unemployment benefits from nearly three years to just one. They made it easier to fire workers, while encouraging the creation of part-time and short-term jobs. The Organisation for Economic Cooperation and Development (OECD) reports that, from the mid-1990s to 2008, the incomes of the poorest 30% of Germans actually declined in real (inflation-adjusted) terms.

Germany’s repressive labor policies kept a lid on wage growth. In every year from 2000 through the onset of the financial crisis in 2009, German compensation per employee increased more slowly than the eurozone average, and less even than in the United States. During the 1990s, German workers’ real wages rose along with productivity gains, meaning that employers could pay the higher wages without facing higher labor costs per unit of output. After 1999, wage gains no longer kept pace with productivity, and the gap between the two widened. As wages stagnated, inequality worsened, and poverty rates rose. Total labor compensation (wages and benefits) fell from 61% of GDP in 2001 to just 55% of GDP in 2007, its lowest level in five decades.

German wage repression went even further than necessary to meet the 2% inflation target mandated by the eurozone agreement, and insisted upon by German policymakers. Unit labor cost (workers’ compensation per unit of output) is perhaps the most important determinant of prices and competitiveness. Unit labor cost rises with wage increases but falls with gains in productivity. From 1999 to 2013, German unit labor cost increased by just 0.4% a year. The reason was not German productivity growth, which was no greater than the eurozone average over the period; rather, it was that German labor-market policies kept wage growth in check. This combination of a built-in system of currency manipulation afforded by the euro and labor-market policies holding labor costs in check turned Germany into the world’s preeminent trade-surplus country. As its competitive advantage grew, its exports soared. Germany’s current account surplus became the largest in the world relative to the size of its economy, reaching 7.6% of the country’s GDP, more than twice the size of China’s surplus compared to its GDP.

Beggar Thy Neighborhood

Germany’s transformation into an export powerhouse came at the expense of the southern eurozone economies. Despite posting productivity gains that were equal or almost equal to Germany’s, Greece, Portugal, Spain, and Italy saw their labor costs per unit of output—and in turn prices—rise considerably faster than Germany’s. Wage growth in these countries exceeded productivity growth, and the resulting higher unit labor costs pushed prices up by more than the eurozone’s low 2% annual inflation target (though by only a small margin).

The widening gap in unit labor costs gave Germany a tremendous competitive advantage and left the southern eurozone economies at a tremendous disadvantage. Germany amassed its ever-larger current account surplus, while the southern eurozone economies were saddled with worsening deficits. Later in the decade, the Greek, Portuguese, and Spanish current account deficits approached or even reached alarming double-digit levels, relative to the sizes of their economies.

In this way, German wage repression is an essential component of the euro crisis. Heiner Flassbeck, the German economist and longtime critic of wage repression, and Costas Lapavistas, the Greek economist best known for his work on financialization, put it best in their recent book Against the Troika: Crisis and Austerity in the Eurozone: “Germany has operated a policy of ‘beggar-thy-neighbor’ but only after ‘beggaring its own people’ by essentially freezing wages. This is the secret of German success during the last fifteen years.”

While Germany’s huge exports across Europe and elsewhere created German jobs and lowered the country’s unemployment rate, the German economy never grew robustly. Wage repression subsidized exports, but it sapped domestic spending. And, held back by this chronic lack of domestic demand, Germany’s economic growth was far from impressive, before or after the Great Recession. From 2002 to 2008, the German economy grew more slowly than the eurozone average, and over the last five years has failed to match even the sluggish growth rates posted by the U.S. economic recovery. With low wage growth, consumption stagnated. German corporations hoarded their profits and private investment relative to GDP fell almost continuously from 2000 on. The same was true for German public investment, held back by the eurozone budgetary constraints.

At the same time, Germany spread instability. Germany’s reliance on foreign demand for its exports drained spending from elsewhere in the eurozone and slowed growth in those countries. That, in turn, made it less likely that German banks and elites would recover their loans and investments in southern Europe.

Wage Repression and the Crisis

No wonder Bernanke now describes higher German wages as an important step toward reducing Europe’s trade imbalances. More spending by German workers on domestic goods and imports would help Germany and its trading partners grow, and improve the lot of working people throughout the eurozone.

Of course, much more needs to be done. Putting an end to the austerity measures imposed on Greece and the other struggling eurozone economies would boost their demand as well. In fact, it would also better serve the interests of Germany and the profitmaking class, by helping to stabilize a system from which they have benefited so greatly at the expense of much of the region’s population.

Still, raising the wages of German workers to match productivity gains is, as Bernanke recognizes, surely a step in the right direction. Raising U.S. wages to match productivity gains would help defuse U.S. wage repression and boost economic growth here as well. If Bernanke throws his weight behind that proposition, we’ll truly wonder which side is he on.

JOHN MILLER is a professor of economics at Wheaton College and a member of the Dollars & Sense collective.

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