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About That Raise You Didn't Get...

The last couple of weeks have brought more news of job cutbacks at companies such as Lucent (LU), SBC Communications (SBC), Intel (INTC), and Siebel Systems (SEBL). Such layoffs, if they continue, make it unlikely that the unemployment rate, now at 5.9%, is going to drop soon.

That's bad news for workers who were hoping for pay hikes to make up for their shrinking stock portfolios. With unemployment high, real wage growth has slowed sharply. In the second half of 2000, average hourly earnings for production and nonsupervisory workers rose by 1.8%, after adjusting for inflation. That fell to 1.1% in the second half of 2001, then to a paltry 0.5% in the first two quarters of 2002.

Real wage growth may even go negative sometime soon. An unemployment rate of 6% is likely high enough to exert downward pressure on wage growth. Certainly it was true during the early 1990s that real wages kept falling until unemployment was well below 6% on a sustained basis in 1995.

Some hard-hit industries are already seeing wages falling even without adjusting for inflation. The latest numbers show wage declines over the past year at telephone-equipment makers, electronics stores, advertising and public-relations firms, book publishers, and companies doing integrated systems design. Other industries with wage hikes below the rate of inflation include magazine publishers, commercial printers, and temporary help agencies.

Some industries have resisted the downward trend. Pay at hospitals rose 6% over the past year, while wage growth has stayed strong in computer maintenance and repair as companies fixed their current gear rather than buy the latest technology. And wages rose 5.9% in the accounting industry over the past year.

But high unemployment will eventually curb wage growth even in these industries. After the 1990-91 recession, it took four years for real wages to start climbing back. The same thing could happen again. Chronically weak growth, minimal inflation, mediocre productivity, and a plunging stock market: Today's Germany looks much the way Japan did in the early 1990s. If Berlin doesn't take urgent action to deregulate sclerotic markets and give the economy a boost, economists warn, the nation could get sucked into a vicious Japan-style circle of near-zero growth, declining competitiveness, and falling prices.

"Gone are the days when Germany was a locomotive for the rest of Western Europe," says J?rn Quitzau, an economist at Deutsche Bank in Frankfurt. "The fear now is that it could become a second economic trouble spot [like Japan], with little momentum and reliant on other countries for most of its growth."

The situation isn't as bad as it is in Japan. Unlike Japan, Germany is expected to show positive growth in 2002, and the country has still not sunk into deflation (chart). Moreover, because Germans are covered by generous social security schemes, they don't need to build up huge precautionary savings accounts, as the Japanese have done. As a result, domestic demand has held up better in Germany. And while problem loans are mounting, German banks are far stronger than their debt-laden Japanese counterparts.

But Germany's prospects are deteriorating by the day, and policymakers are unwilling or unable to take action. The Bundesbank can't cut interest rates to kick-start growth--it lost the freedom to do that when the euro was launched in January, 1999. And it's difficult for the government to oil the wheels with extra public spending or tax cuts since its budget gap is very near 3% of gross domestic product, the ceiling imposed by the European Union's Stability & Growth Pact. With a general election in September, neither the government nor the opposition is willing to champion much-needed but unpopular reforms, such as labor market liberalization.

Many economists predict that whoever wins the election will come under intense pressure from business, the financial markets, and Germany's European Union partners to force through major changes, especially painful restructurings. But, like Japan, Germany is governed by consensus, which makes it difficult to enact controversial reforms. "The consensus society is unlikely to provide the flexibility needed in today's rapidly changing business world," says Quitzau. Germany and its trading partners could be about to find that out the hard way. It has long been common wisdom that drug addiction is linked to criminality. During the 1990s, however, public policy focused more on putting criminals behind bars and less on drug treatment.

But a study suggests that spending more money on treating drug addicts would pay off as well. Mireia Jofre-Bonet and Jody L. Sindelar, faculty at the Yale School of Public Health examined data on 3,500 inner-city drug users entering treatment in the Philadelphia area between April, 1985, and May, 1998. The data recorded criminal behavior as well as the change in the use of different drugs, such as heroin, during treatment.

The authors found that treating drug abusers reduced the crime they committed by 51%. Jofre-Bonet and Sindelar also note the cost advantages of drug treatment over prison. A year in the jug costs $23,000 per inmate, compared with a $3,000 annual tab for methadone treatment of heroin addiction.

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