What is the risk of wage inflation in Europe? – BRINK – Conversations and insights into global affairs

With each new reading of inflation in Europe, fears that price rises are becoming chronic and causing unchecked wage-price spirals are growing. Joachim Nagel, head of the German Bundesbankrecently tried to calm the nerves of the public by saying that he could very well understand that the unions factored high rates of inflation into their demands, especially given the greater impact of inflation on the incomes of the weaker.

However, he added, “salary negotiators have acted very responsibly over the past 25 years. I’m sure they will do it this time too. Is it justified not to worry more about the specter of possible wage inflation in Germany? And what does German history say about the wider context of the EU?

A shortage of workers

There is some evidence to suggest that the Bundesbank’s demonstrative confidence in Germans’ innate wage moderation may not be entirely justified. Despite the rapidly cooling economy and rising unemployment, German companies are desperately looking for better-qualified employees – and can’t find any.

In Germany, two million jobs are currently to be filled, an increase of more than 60% compared to last year. According to IAB research, a German labor market research institute, the main reason for the current shortage is structural, as baby boomers retire and employers struggle to replace them. Between 2020 and 2035, the IAB expects the shortage to reach seven million vacancies. Even allowing for the caveat that longer-term projections should be taken with a grain of salt, this is a rather bleak scenario for Europe’s economic powerhouse.

As part of a narrative of the growing bargaining power of employees, ousting of Volkswagen AG CEO Herbert Diess in July made headlines in part because it advocated cutting up to 30,000 jobs. Some observers have interpreted his departure as a sign that the unions are regaining the upper hand, after decades of declining power.

However, the latest data shows that unions are still struggling to retain their membership. The downward trend continued in 2021, despite economic uncertainties related to COVID. Only one in six workers in Germany is a member of a trade union. And recent wage negotiations suggest that wage moderation may not be dead yet after all.

The UK already provides a cautionary tale. There, the risk that inflation resists all attempts to bring it down to the level of 2% set by the Bank of England is even greater than on the continent.

Wage moderation is not dead yet

Various sectors, from banking to insurance, via textiles, have agreed to limit wage increases to a range of between 3 and 4.5%. The only exception so far is the steel industry, which achieved a more substantial increase of 6.5%, still below the current rate of inflation. Further wage negotiations for the manufacturing sector will take place in the fall with the IG Metall union demanding wage increases of 8%.

With few exceptions, wage negotiations have followed a pattern that began in the first decade of the euro, with unit labor costs growing steadily below the common inflation target.

Only since 2011, at the height of the euro crisis, has there been sustained real wage growth in Germany, briefly interrupted by the COVID pandemic. Yet even sustained wage growth over the past decade has not absorbed all of the earlier undervaluation vis-à-vis most of Germany’s most important eurozone partners. The fact that wage moderation has become a common feature of most euro area partners wishing to reduce past differences in unit labor costs has helped to reduce the differences with Germany, but this has not been enough to eliminate.

A notable feature of wage growth in Germany has been the variation across sectors of the economy, with unit labor costs rising much faster in manufacturing and finance and much slower in construction, public sector and services such as hospitality and retail.

Wage negotiations are now more likely at company level

Moreover, in recent decades most sectoral bargaining has been replaced by wage bargaining at the level of the individual company. One of the best-known examples of this way of setting salaries is, in fact, Volkswagen. It is a model adapted to the specificities of each company and its employees. This is no doubt what many workers in some US-based companies are trying to emulate.

However, the German model is not uniformly adopted across Europe and wage setting still differs from country to country. The longer it takes to bring price pressures under control, the greater the risk that sectoral wage-setting processes result in larger inflation differentials between countries.

In the eurozone, such an outcome would greatly complicate the ECB’s ability to uniformly set monetary policies for the single currency. A higher interest rate in one country may not meet the needs of another. So far, this risk has not materialized. With some minor differences, the forces driving inflation in the largest eurozone economies, such as France, Germany and Italy, are still driven by similar factors.

Over time, wage inflation could rise

However, the inability to control prices over an extended period risks altering the dynamics, as the credibility of policymakers and institutions such as central banks erodes and the risks of policy errors increase, making a wage spiral more likely. -price.

A look across the Channel to the UK already provides a cautionary tale. There, the risk of inflation resisting all attempts to bring it down to the 2% level set by the Bank of England is even greater than on the Continent, largely because the country faces an additional, structural factor fueling inflation. , Brexit. The wave of summer strikes in the UK has overshadowed similar eruptions of discontent on the Continent.

Even the independence of the UK’s central bank has come under attack from some prominent UK politicians. As the purchasing power of British citizens continues to erode, more politicians will inevitably be tempted to abandon sound policies and seek dubious and quick short-term solutions, creating more favorable conditions for inflation. prices and wages.

Mary I. Bruner