Lofty Wage Demands Risk Weighing on German Economy

While German wage demands promise to spur domestic consumption, they also risk putting longer-term pressure on Europe’s biggest economy.

Even as benchmark bund yields hover close to the lowest level since reunification in 1990, offering shelter from the region’s debt crisis, analysts and policy makers said German industry will lose its edge if wages rise too fast.

IG Metall, Germany’s most powerful labor union, is seeking pay increases of 5.5 percent for 3.7 million engineering and metal workers at companies, including Bayerische Motoren Werke AG, Siemens AG, Daimler AG and Volkswagen AG, before the current contract expires on April 30. That comes on top of 4.3 percent won last year. IG Metall locked in a 3-percent wage deal for 75,000 steelworkers on March 6.

The pace of salary gains may be “disastrous” for Germany and the euro-area economy, Deutsche Bank AG chief economist David Folkerts-Landau said at a financial summit in Frankfurt last week. The 17-nation currency bloc and its largest member would “lose competitiveness vis-a-vis the rest of the world,” he said.

While the union says German wage increases at more than 3 percentage points above the rate of inflation will help a shrinking euro-area economy by boosting consumption, policy makers such as European Central Bank Executive Board member Joerg Asmussen and Chancellor Angela Merkel are less optimistic.

Merkel’s View

Wages increasing at a faster rate than productivity is “something we need to keep an eye on,” Merkel said March 20 in Berlin.

Asmussen, who was a state secretary in the finance ministry before joining the ECB in January 2012, took the state of the German economy to task in a speech last week in Frankfurt. To maintain its lead in Europe, Germany may need a second set of labor market reforms to follow on from former Chancellor Gerhard Schroeder’s Agenda 2010, he said.

“Germany was a decade ago called the ‘sick man’ of Europe,” Asmussen said. “Since then, the country has become a showcase of how well-designed reforms can turn the situation around. But this example also serves as a warning. Others can just as quickly catch up. If struggling countries continue to pursue ambitious reforms and Germany rests on its laurels, it could once again be this country left in the slow lane.”

Trade Balance

With unemployment near a 20-year low and exports reaching a record 1.1 trillion euros ($1.42 trillion) last year led by locally made high-technology machinery and automobiles, Germany’s economy looks the picture of health. The nation’s trade balance has been positive each year since reunification.

While the euro area is stuck in its second recession in four years, the German economy grew 0.7 percent in 2012 and the Bundesbank expects growth of 0.4 percent this year. Investor confidence unexpectedly rose to a three-year high this month and retail sales climbed by the most in more than six years in January.

The benchmark DAX Index has gained 4.9 percent since the start of the year after advancing 25 percent in 2012. The yield on the 10-year bund stood at 1.41 at 8:20 a.m. in Frankfurt, down 50 basis points, or half a percentage point, from the March 22 close a year ago.

Germany’s strong economy and its trade surplus are reasons “why there’s still room to increase wages,” Andrew Bosomworth, managing director at Pacific Investment Management Co. in Munich, said in a March 22 telephone interview.

Germany’s Competitiveness

“That’s particularly true if you compare German wages to those in other European countries,” he said. “The real competition takes place internationally vis-a-vis other export countries like Japan or China. That limits the room for increases, but I don’t think that at this stage higher wages are seriously damaging Germany’s competitiveness.”

On the negative side, companies, including Beiersdorf AG, the maker of Nivea skin cream, and Adidas AG, the world’s second-largest sporting-goods maker, recently reported earnings that fell short of analysts’ estimates amid stronger international competition. German business sentiment dropped unexpectedly last week for the first time in five months.

Deutsche Lufthansa AG scrapped more than 760 European flights last week as cabin crew and ground personnel went on strike to oppose Chief Executive Officer Christoph Franz’s plan to freeze pay as part of an initiative to lift operating profit to 2.3 billion euros by 2015.

Relative Costs

While labor costs increased by an average 1.6 percent per year between 2002 and 2011, they rose by an average 2.1 percent from 2008 to 2011 and jumped 2.6 percent in 2012, the German statistics’ office reported on March 11.

In Spain and Portugal, relative unit-labor costs fell below Germany’s for the first time since 2005, according to the Organization for Economic Cooperation and Development.

Data from Eurostat, the EU’s statistics arm, show that productivity isn’t keeping pace with the cost of Germany’s 42-million workforce. Eurostat estimates that productivity declined 0.2 percent in 2012 and growth will be 0.5 percent in 2013.

“It is important to have competitive prices if you want to stay successful as an export nation,” said Christoph Schroeder, an economist at Cologne Institute for Economic Research specializing in unit labor costs. “A lot of other countries have made progress in the past few years, and Germany hasn’t. To ask for much higher wages in such an environment is endangering Germany’s competitiveness.”

While Germany’s industrial manufacturers are more competitive than many of its euro-area peers, they lost ground over the past five years to Spain, the Netherlands and Austria and were outperformed by countries such as the U.S. and Canada to Japan and South Korea, according to the U.S. Bureau of Labor Statistics.

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