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Are German workers killing Europe? In other words, have their low relative wages created a "beggar-thy-neighbor real devaluation"* policy highly destabilizing to the Eurozone?

Article Excerpt
Background: To what extent are productivity gains at the expense of wage growth and consumption holding back the German economy and thus the entire Eurozone economy? In Germany, real incomes and unit labor costs have fallen in recent years and are expected to fall again next year. As a result, the export industry is booming while consumer demand stagnates. Not surprisingly, the IFO index and other confidence indicators for industry continue to soar even as consumer confidence drags. As some analysts have put it, household spending has become Germany's Achilles heel of economic development.

Some argue that German industry is being increasingly delinked from the broader German economy as production and sales are increasingly geared more toward foreign buyers. Meanwhile, the argument goes, this ongoing process has led to Germany undercutting the competitiveness of other euro-area countries, including Italy, Portugal, and Greece. The Financial Times has dubbed this a "beggar-thy-neighbor real devaluation" policy.

Some analysts suggest higher German wage increases would rebalance this situation. Others argue that the main cause for Germany's continuing economic weakness is structural and thus greater market liberalization is the answer.

Can the German economy continue to be comprised of world-class export companies positioned well in the global economy sitting side-by-side with a disillusioned domestic household sector? To what extent is this dichotomy in the German system sustainable, for both Germany and Europe?

OTMAR ISSING

Former Chief Economist and Member of the Executive Board of the European Central Bank

Germany is a country with wages among the highest in the world and a double-digit rate of unemployment for many years by now. Hardly a case to ask for higher wages. Germany being a member of European Monetary Union does not change the argument. What would you recommend if a region within the boundary of a country with its own currency were in such a situation? Higher wages? Certainly not.

It is true that Germany has regained competitiveness via wage constraint in relation to other members of EMU over the last years. But, one must not forget that this has been to a large extent a correction of real overvaluation at the start of EMU. In some countries unit labor costs have risen substantially due to strong increases in wages. It is high time that these countries reverse this process.

Continuous and growing divergences as a consequence of wage increases above productivity within EMU will create economic and finally also political tension. But this diagnosis should not lead to a prescription of the wrong medicine.

SAMUEL BRITTAN

Columnist, Financial Times

A wise inter-war Marxist once said that anti-Semitism the socialism of the stupid. In the same way, artificially raising wages is the reflation of the economically illiterate.

Classical economists have normally insisted on the link between wages and employment. A wage is a price, and if it is too high workers are priced out of jobs. Keynes's supporters replied that wages are also a source of purchasing power and if wages are cut, the market for the product of business and industry would also be reduced.

A synthesis of the two positions is not difficult. Full employment does require a flexible labor market. But this will work best if monetary and fiscal policy aims to sustain final demand in nominal terms so that purchasing power is maintained. The aim can be described in different ways--whether a monetary target pursued with common sense or a policy aimed at maintaining nominal GDP.

This route is however not available to members of the euro monetary zone, as there is a single monetary policy applied to national economies with very different characteristics. And the safety valve of national exchange rate changes has been removed.

Enthusiasts for European monetary union hoped that its establishment would itself be a force for convergence of labor costs so that relative exchange rate changes within the zone could be abandoned. (This is at least how the aim should have been expressed.) They have been sadly disappointed. Since the union was established in 1999 German unit labor costs in manufacturing have risen in most years by a fraction of a percent and in the last two years they have actually been falling by around 1 percent per annum. At the other extreme, Italy has had labor costs rising by nearly 4 percent per annum and even faster in the last couple of years. France has been somewhere in between.

So long as the euro lasts, the only real exchange adjustments available to members have to work through wages. Instead of lecturing Germany for overachieving, it would be better if other members could work towards both lower labor cost increases and more flexibility between different sectors and corporations. The European Central Bank could also help by indicating that wage moderation would not be offset by lower final demand. It does not have to make unwise deals with national governments or unions to do this, but simply slightly adjust its oratory and show that it means it.

As for Germany, despite the improvement in overall labor markets, there are many other inflexible elements including nationwide wage bargaining and various corporatist deals and laws which make it very difficult for different sectors of the economy to move in their own way.

There is also a cultural factor regarded as politically incorrect to mention. This is that in the German tradition economic success is linked with manufacturing and exports, while services and consumption are regarded as somewhat sissy. This has now given Germany the dubious benefit of...