Rising German pay not enough to buoy Europe, say economists

Weakening in workers' negotiation power hurts strong wage growth
By John O'Donnell
|payroll-reporter.com|Last Updated: 09/23/2015

BERLIN (Reuters) — German companies are finally increasing wages but economists say slack wage growth elsewhere means the impact on consumer spending will still not be enough to kickstart a broader euro zone recovery.

For years, German salary restraint has allowed its industry, from car manufacturing to heavy machinery, to thrive -- often to the detriment of European neighbors experiencing faster growth in their labor costs.

A 2003 overhaul of labor law by then chancellor Gerhard Schroeder put an even greater damper on salaries, putting five million, or one in six, German workers solely into part-time jobs earning about 100 euros (US$112) a week.

Now, low unemployment of 6.4 per cent means wages are finally climbing: After rising just two per cent last year, German pay jumped 2.7 per cent in the first six months of 2015, the strongest increase since records began in 2008.

But economists say that momentum is still not enough to counter-act the insipid outlook in the other large countries of the 19-member currency bloc, where wage growth is modest and the threat of deflation, or falling prices, continues to loom.

Salaries in France, which accounts for about one fifth of the euro zone economy, are increasing at half the rate seen in Germany so far this year. Pay in Spain rose by just 0.5 percent in the second quarter of this year while Italian wages shrank.

Although wages across the euro zone grew by 1.9 per cent in the first half of this year, economists believe they would need to rise by 3 per cent or more in order to filter down to prices and put euro zone inflation - currently a meager 0.1 percent - on track to meet the European Central Bank's two percent target.

"Germany is not doing nearly enough on wages," said Zsolt Darvas, an economist with Brussels think tank Bruegel.

"For the euro zone to hit its inflation target of 2 per cent, Germany has to reach between 3 and 4 per cent (inflation). And for that to happen, its wages need to grow by 4-5 per cent."

German year-on-year inflation is currently just 0.2 per cent.

PRESSURE ON DRAGHI

The trends are being watched closely by ECB president Mario Draghi, keenly aware of the importance of wages in underpinning spending and a fragile economic recovery.

Spending by their citizens typically accounts for more than half of European countries' output. If that falls, it makes it harder for the European Central Bank's 1-trillion-euro-plus money-printing scheme to work.

Peter Bofinger, one of the "wise men" who advise the German government on economic policy, warned a weakening in workers' negotiation power has hurt prospects for strong wage growth.

"Wages are growing too slowly," he said. "If they were to increase, then it would take the pressure off Draghi."

Others agree.

"In Germany, there is scope for ... stimulating the demand side of the economy including wages," said EU Commissioner Valdis Dombrovskis, who attends ECB Governing Council meetings and visited Berlin this week.

"With German stimulating ... it also has positive spillover effects to other EU countries."

There is little resonance, however, for this argument in Germany, which produces about 30 per cent of euro zone output, and where rampant inflation before and just after World War Two still shape thinking. Keeping pay down, goes the German mantra, moreover helps countries keep costs low when selling abroad.

In an interview with Reuters this month, ECB Vice-President Vitor Constancio played down the risk that weak wage growth could ever drive Europe toward the situation seen in Japan, in which falling prices have prompted consumers to delay purchases and so undermine efforts to generate growth.

"There is more rigidity in wages in a recession (in Europe) and ... that is why I never really feared we would have actual deflation," the former Portuguese politician said.

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