How The German Minimum Wage And Investment Could Help The Eurozone

Henning Meyer

Henning Meyer

The new German government has now started work in earnest following its formation just before Christmas. As ministers get to work on their projects the big question is whether there will be significant policy changes and what impact such changes would have on Germany and the still unresolved Eurozone crisis. The short answer is that there will be positive change but much more should be done.

The sobering part is that in terms of redesign of the Eurozone quick progress is as unlikely as it was last year. The coalition treaty only makes brief and unambitious references to the malaise of the European Union, which means that we are stuck with imperfect solutions for the foreseeable future. Shared debt liability is explicitly ruled out and there is also no fundamental shift away from the austerity policies that have created so much damage in many European countries.

The ECB’s OMT, currently under investigation by the German constitutional court, has provided some crisis relief but the time bought has not been used to push forward necessary institutional reforms. What is proclaimed as a banking union will include a common supervisor for big banks but no joint bank resolution fund or a joint deposit insurance scheme. Therefore the fundamental objective – breaking the vicious link between financial sector vulnerability and the solvency of governments – will not be achieved.

But not all is bad. If you look at the domestic agenda of the new government, it becomes clear that there will be some significant help towards the rebalancing of the Eurozone. It is, however, yet another sign of the systematic misunderstanding of the Eurozone crisis that the positive European impact of these domestic polices are largely left unmentioned. It is therefore worth pointing this out.

The introduction of Germany’s first statutory minimum wage of 8.50 Euro per hour is likely to have a significant macroeconomic impact and help address Germany’s chronic shortage of domestic demand. According to statistics published by DIE ZEIT, the introduction of the minimum wage will result in a pay rise for almost 7 million German workers. This means 32.2% of workers in former Eastern Germany and 18.0% in the former West will see a pay rise as a result of this policy. Put this together with now more common above inflation wage increases higher up the payscale, which even the Bundesbank sees as a “normalisation”, and we are likely to see a significant boost of domestic demand.

This increased domestic demand will also help to bring down the hitherto growing trade surplus that has been a cause for concern in Europe and beyond. It should also help driving up German inflation, which in turn will help to counterbalance deflationary pressures elsewhere in the Eurozone. Does this mean that hyperinflation is around the corner? No. Far from expecting a massive surge of inflation, as is so often feared in Germany, the Bundesbank currently expects German inflation rates to be between 1.3% in 2014 and 1.5% in 2015.

The changing wage trend’s likely effect on inflation, however, also points to the big omission in the new government’s agenda. In times of real interest rates close to or even below zero, the new government should be investing massively in the country’s crumbling infrastructure. Few people know that Germany has a very low investment ratio and has built up a substantial investment gap over the last ten years or so.

The Macroeconomic Policy Institute of the Hans Böckler Foundation estimates that 6bn Euro additional investment each year is necessary just to eliminate the shortfall built up over the last decade. And the DIW Institute in Berlin even estimates that additional public and private investment of 75bn Euro per year would be helpful to eradicate the 1tn Euro investment gap the institute believes the country has accumulated since 1999.

Borrowing costs are at record lows and Germany has a dire need for substantial investment. View this situation against the backdrop of massive unemployment in southern Europe, not least in the construction sector, and one really has to wonder why the new government is not waking up to the fact that this is the ideal moment to start a multi-year investment programme that will help increase German productivity, further increase domestic demand and help rebalance the European labour market.

The introduction of a statutory minimum wage and general wage increases in Germany will have a positive effect on the Eurozone. But it is hard to understand why there is not even a discussion about a substantial investment programme. It is good economics and good politics for Germany as well as the wider Eurozone. Decision-makers need to learn that it is clever investment rather than dogmatic saving that drives economic progress. They already understand that crises also bring opportunities, but it is high time to realise that there are also opportunities that help to solve crises.