Economy and Society – Analysis & Opinion regularly evaluates whether the development of the different wage indicators offered by official statistics corresponds with the development of labour productivity plus the inflation target of the European Central Bank (ECB). If wages develop in line with productivity they are neutral with respect to production costs; if wages additionally develop in line with the inflation target they are neutral with respect to the desired inflation rate, too. However, contrary to that rational definition, the term “labour cost” is quite differently used not only by employer associations and politicians with their specific interests but by official statisticians and economists, too.
The statistical office of the European Union, for example, Eurostat, defines labour cost this way (see ): “The quarterly Labour Cost Index (LCI) is a Euro Indicator which measures the cost pressure arising from the production factor ´labour´.” That is obviously wrong, since whether increasing wages mean increasing “cost pressure arising from the production factor labour” depends on the development of labour productivity. If the wage increase equals the productivity increase then the wage increase means no additional “cost pressure”, it is neutral; if the wage increase is lower then the productivity increase there is even less “cost pressure”; only if the wage increase surpasses the productivity increase there arises cost pressure from the production factor of labour.
This has far reaching consequences. First, the onesided discussion of wages as a cost factor itself determines the development of wages. In that view, an increase in “labour costs” often suggests per se a burden to the economy. Second, since the development of wages in relation to productivity determine inflation, countries following that doctrine gain competetiveness by wage dumping (wages falling behind productivity and the inflation target). That has been exactly the case in Germany soon after the beginning of the European Monetary Union (EMU) when the former Chancellor Gerhard Schroeder and the red-green coalition introduced a set of so called “reforms”, known as Agenda 2010, putting much pressure on wages. That economic and social policy has contributed to huge current account imbalances. The critical evaluation of that development by the U.S. Department of the Treasury Office of International Affairs in 2013 has become even more pertinent today than it was in 2013, since the “deflationary bias for the euro area” has become even more virulent:
“The Netherlands and Germany have continued to run substantial current account surpluses since 2011, while the current accounts deficits of Italy and Spain and the smaller economies in the periphery have contracted significantly, primarily as a result of a collapse of domestic demand and falling wages. Ireland, Italy and Spain have run surpluses in recent quarters, and Portugal moved into surplus in the second quarter of 2013. Germany’s current account surplus, meanwhile, rose above 7 percent of GDP in the first half of 2013, with net exports still accounting for a significant portion (one-third) of total growth in the second quarter, suggesting that rebalancing is not yet occurring domestically. To ease the adjustment process within the euro area, countries with large and persistent surplus need to take action to boost domestic demand growth and shrink their surpluses. Germany has maintained a large current account surplus throughout the euro area financial crisis, and in 2012, Germany’s nominal current account surplus was larger than that of China. Germany’s anemic pace of domestic demand growth and dependence on exports have hampered rebalancing at a time when many other euro-area countries have been under severe pressure to curb demand and compress imports in order to promote adjustment. The net result has been a deflationary bias for the euro area, as well as for the world economy. Stronger domestic demand growth in surplus European economies, particularly in Germany, would help to facilitate a durable rebalancing of imbalances in the euro area. The EU’s annual Macroeconomic Imbalances Procedure, developed as part of the EU’s increased focus on surveillance, should help signal building external and internal imbalances; however, the procedure remains somewhat asymmetric and does not give sufficient attention to countries with large and sustained external surpluses like Germany.”
Here is the most recent development of “labour costs” in Germany; it shows that the development of wages – though wages/”labour costs” increase – again increasingly lags behind the development of productivity plus the inflation target of the ECB, indicating decreasing cost pressure with negative distribution effects to employees and to domestic demand:
Click to enlarge chart.
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