Investment Contrarians

What’s Needed for Higher Wages?

By for Investment Contrarians |

What’s Needed for Higher WagesSometimes it is interesting to get a different perspective by looking at other nations around the world and how they are dealing with their economies.

The U.S. economy is certainly not booming, although the latest data have shown some contradictory indications. On the one hand, job creation is not occurring at an extremely fast pace; however, there are signs of an economic recovery in certain sectors, including housing, vehicle sales, and energy.

Germany, on the other hand, has had a lot of success, even though its neighbors have been embroiled in a large amount of economic stress due to their financial crisis. The economic recovery of Germany goes back many years, with structural reforms, made over a decade ago, that have prepared its economy to be extremely competitive internationally. The decrease in the euro has only helped the country’s economic recovery.

According to the German Federal Statistics Office, exports for the first 11 months during 2012 grew 4.3% to $1.3 trillion. This includes a 10.4% increase in exports to non-European Union (EU) countries. In another report, conducted by the Federation of German Wholesale, Foreign Trade and Services, export growth is expected to increase by five percent in 2013. (Source: “Booming Sales Beyond Europe German Exports Seen Hitting New Record in 2012,” Der Spiegel, January 8 2013.)

These are record levels of exports for Germany. Clearly, that nation has been able to engineer a decent economic recovery in spite of its weaker European partners. Job creation throughout the financial crisis has been quite strong, as Germany currently employees over 41 million citizens, the highest level ever recorded.

Much of the problem for European nations in job creation is the difference in costs and productivity across countries. The structural reforms made by German labor and industry a decade ago has allowed for strong job creation due to high levels of productivity. The truth is that the southern European nations are still far too costly in relation to countries, such as Germany.

This disparity is now leading unions in Germany to demand much higher wages. Proponents of higher German wages state that this will help the overall economic recovery for Europe by allowing the spread in costs between Germany and its southern partners to narrow. This, of course, is not good for shareholders and business owners of German firms, as it looks like costs will certainly be rising on the employment side in the future.

Frank Bsirske, the head of Verdi, one of the largest trade unions in the world with 2.1 million members, is demanding a 6.5% increase in pay for all German public employees. Many other unions are also demanding increases in compensation, including IG Metall, a metal workers union. (Source: “Possible Boost for EU Economy Germany Gears Up for Big Pay Hikes,” Der Spiegel, January 8 2013.)

Creating job creation through an economic recovery takes hard work. Because of the higher relative cost of wages in southern Europe, industry has continued pouring money into Germany, with its elevated levels of productivity and its reputation for an extremely high quality of production.

This combined with a euro that has declined significantly has helped the German economic recovery, along with local job creation.

However, while it might help job creation in southern nations on the periphery by increasing the cost of wages in Germany, over the long term, the economic recovery will not be as strong as it would be if structural reforms were actually made.

These were the hard decisions made a decade ago in German labor and industry leaders—decisions that the “PIGS” countries (Portugal, Italy, Greece, and Spain) never made.

If you looked at the actual labor rules in Greece and Italy, for example, you would be quite surprised at the arcane rules prevalent. Ultimately, job creation and economic recovery are not fueled by wage inflation. Wage inflation starts to create endemic price inflation throughout an economy.

Inflation that stems from commodities is easily adjusted. The price of oil can go up or down by $5.00 without an issue. Lowering wages to adjust to a weak economy is not easy to do at all. This has been the problem with the PIGS of Europe.

Traditionally, countries with high labor costs ended up with high inflation, which lowered the currency and made them more competitive. However, by creating a union of strong and weak countries with radically different labor markets, this adjustment mechanism is not possible.

For a true long-term economic recovery to ensue and for job creation to be prevalent throughout the EU, it takes more than increasing wages in Germany. There needs to be structural reforms made to labor markets to increase flexibility and promote business creation.

It’s fine for workers to ask for higher wages if they earned them. But to justify higher wages to help Spanish or Greek workers is erroneous. If the labor market is not reformed, after an adjustment period, the PIGS nations will remain uncompetitive.

At the end of the day, job creation comes from businesses. By creating an environment that supports the creation of new businesses and the expansion of existing companies, this will lead to job creation and economic recovery.

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