Labor relations

Flexible German Unions Bend the Phillips Curve

IG Metall-Demo
German workers want to have a say in their working hours (Arbeitzeit). Source: DPA

If there is one economy in the euro zone where wages should start to pick up, it is the German economy. However, since 2009, nominal wages have only increased by an average of roughly 2 percent a year. In real terms, after accounting for inflation, wages increased by only around 1 percent every year. Better than nothing but not the wage growth one could expect in an economy that is in its ninth year of strong growth and in a labor market that breaks new employment records almost every single month.

The European Central Bank, which is trying to find ways and reasons to slowly exit from its ultra-loose monetary policies, has been eyeing German wages for a long while. To paraphrase Frank Sinatra: If wage inflation does not pick up there, it will not pick up anywhere (else in the euro zone). The ECB has probably set its hopes on this fall’s wage negotiations in Germany, finally seeing the long awaited spur in wage inflation. A big disappointment is in the making as German unions are, to stick to Sinatra, doing it their way.

The European Central Bank has been eyeing German wages for a long while.

This week, Germany’s largest trade union, IG Metall, came out with its usual demand for a wage increase (of 6 percent over two years). But the surprise was that the union seemed to be more interested in increasing its members’ leisure time for work-life balance. It called for reducing the current 35-hour-week to 28 hours per week. This is part of an interesting trend, which in our view reflects the changing structure of the German labor market and the changing preferences of employees, against the background of a lack of qualified workers. More leisure time; not more money.

This trend, however, spells trouble for the ECB. As long as wages remain low, it is harder for the central bank to tighten its monetary stance. However, if it keeps its monetary policy stance unchanged, despite strong economic growth in the entire euro zone, the risk of misallocations and bubbles increases. Recently, a lot has been written about the changing relationship between dropping unemployment rate and wages. ECB President Mario Draghi even called wages the linchpin of the central bank’s monetary policy. In times of higher inflation and weaker growth, weak wage growth was a welcome reason to extend ultra-loose monetary policies. Now that growth is strong again, weak wage growth is a conundrum that makes the ECB’s decision to move toward the exit of its unconventional measures so difficult.

13-The-Phillips-Curve-update
The Phillips curve, named after the New Zealand economist William Phillips, describes a historical inverse relationship between rates of unemployment and corresponding rates of inflation. Simply put, when unemployment drops, inflation rises.

Up to now, the ECB has sought comfort in a famous concept of economics called the Phillips curve. Named after William Phillips who came up with the idea in 1958, this curve describes the inverse relationship that he observed between unemployment rates and inflation. Based on this premise, the ECB’s economists have consistently predicted that wage growth in the entire euro zone must be about to accelerate.

Unfortunately, their projections appear to be no better than wishful thinking. Several factors are keeping wage increases structurally low – in Germany, but also in the entire euro zone. Though the official unemployment rate is low, Germany’s labor markets still have a lot of hidden slack. Many people are in low-wage jobs, or involuntarily in part-time or temporary jobs. Hidden unemployment, a huge low-wage sector and the influx of refugees are probably the main reasons for sluggish wage growth. The problems in the automotive industry, the threat of automatization, globalization and downward pressure on wages and prices from digitalization don’t help either.

And now there is this new factor, of which IG Metall’s step this week may be only one harbinger: German labor itself seems increasingly uninterested in fighting for high wages, as the trade-offs between money and leisure time shift in this ageing and prosperous society. Perhaps it’s time to revisit the Phillips Curve in economic theory, as well as the assumptions used by the ECB, and a lot more besides.

To contact the author: gastautor@handelsblatt.com

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