An ambiguous wage standard is being clarified
Back in 2010, the ‘Competitiveness Pact’ launched the slogan of aligning wages with developments in productivity. Since then, this specific wage standard has been surrounded with much ambiguity. Do policy makers mean to say that ‘real’ wages should be in line with productivity developments? Or do we have to read it exactly in the way as it is written, thus referring to a scenario in which ‘nominal’ wages are to follow productivity?
The first interpretation is similar to the guideline trade unions across Europe have been using for more than a decade to coordinate collective bargaining strategies. With the aim of avoiding mutual competition, trade unions have called upon each other to make sure that both inflation and productivity are reflected in nominal wage agreements.
The second, on the other hand, boils down to the strategy of wage cost stagnation that Germany has pursued since the end of the 1990s up to the 2009 financial crisis. Over this entire period, German nominal wage increases moved exactly in line with productivity dynamics but without providing additional compensation for ongoing inflation. In Germany, nominal unit wage costs (which by definition are the difference between nominal wages and productivity) hardly moved between 2000 and 2008.
On a number of occasions, DG ECFIN has been explicit in following this latter interpretation. For example, in the in-depth country study on Finland from May 2012 that was part of the new procedure on preventing excessive macroeconomic imbalances, DG ECFIN published a graph comparing nominal wage increases with productivity and concluded that wage dynamics in Finland had overshot the standard of aligning wages on productivity.
In the recent Employment and Social Developments in Europe 2012 report, published at the beginning of January, DG Employment and Social Affairs also confirmed this standard of aligning nominal instead of real wages on productivity in the chapter on wage developments:
When nominal unit labour costs increase, it is an indication that nominal wages are rising faster than productivity. When this occurs, there is the risk that prices may need to increase more than the sustainable inflation target of just under 2% per annum (…) (page 12).
A serious mistake
Here, the Commission is making a key error, which can be illustrated by using a graph from the Commission’s report itself (see below). As one can observe, the relationship between nominal unit labour costs and inflation is almost a one-to-one relationship, at least over the time period chosen. When nominal unit labour costs move by 5%, annual inflation tends to be around 5%. When unit labour costs are close to zero, so is inflation. In other words, and in contradiction with the Commission’s assertion made above, zero unit wage costs do not imply 2% inflation, they imply zero inflation.
However, zero inflation is something a central bank does not like to see. Central banks are certainly keen to avoid high and runaway inflation, but they are also allergic to the opposite process of deflation. This is because their toolkit of monetary policy becomes very ineffective in such a situation. Given the zero nominal bound on nominal interest rates, real interest rates rise when prices are falling and inflation is negative. Monetary policy is thus automatically tightened at the very moment it should be relaxed to support the economy.
To avoid getting trapped in this dilemma, any respectable central bank, including the European Central Bank, sets inflation targets above zero. In that way, there exists a buffer against negative demand shocks. If inflation starts falling as a result of such a shock, then the central bank can still hope to avoid deflation by quickly relaxing monetary policy, thereby bringing both nominal as well as real interest rates down before deflation gets entrenched. A positive inflation rate thus functions as a safety margin to ward off the potential danger of deflation. This safety margin does not exist with zero inflation. Zero inflation therefore carries the risk of jeopardising the adequate functioning of monetary policy. This is why the ECB adopted a formal inflation target of no more but also not much less than 2%.
Why zero unit wage costs?
Why is the Commission pushing this wage standard of zero unit labour costs? One explanation would be that the Commission has made a technical error. Another is that such a wage standard allows the significant redistribution of the burden of adjusting wage policies between the different member states of the euro area. On the one hand, zero unit wages allow a shift of the policy discussion away from Germany. For example, the compounded rate of change of nominal unit labour costs in Germany was minus 2,2% between 2000 and 2007. This is close to the zero line, implying very limited upward corrections when trying to bring German wages back in line with the Commission’s standard of aligning nominal wages on productivity. On the other hand, nominal unit labour costs moved by 14 to 20% in the rest of the euro area. Applying the Commission’s wage standard to these member states then results in deep and prolonged process of wage moderation or even wage cuts to get these countries back on a long-term trend of zero nominal unit wage dynamics. In this way, Germany, which happens to be the member state that is de facto pulling the financial strings of the euro area, gets off the hook and is not confronted with much pressure from Europe to adopt different wage policy choices.
European economic governance and the autonomy of collective bargaining
European economic governance is about transferring a significant degree of competence over economic and social policy making from member states to the Commission. This is based on the hypothesis that individual governments focus on their own national economy and are therefore unable and unwilling to pursue policies that are compatible with monetary union.
However, the analysis made above raises serious doubts. If the Commission is prone to committing serious technical mistakes or is de facto acting on behalf of those member states holding the financial power, then a transfer of national competence to the European level will not produce the desired effects. European economic governance would then result in price instability, in underperforming economies and in high and rising unemployment. With people becoming more and more aware of the fact that processes of democratic decision making get weakened by flawed policy decisions being imposed from above, the forces of political extremism and anti-European sentiment will gather strength.
To counter these dangers, Europe and its policy makers should urgently rediscover the value of the autonomy of collective bargaining. If autonomous collective bargaining is enshrined in the European Treaty and ILO conventions as well as in several national constitutions and national practices, it is exactly because autonomous bargaining serves to protect wages and working conditions from interventions by governments and political institutions suffering from ‘regulatory capture’ by particular actors. This is all the more true for the European level, a level where policy decisions are not always that transparent and tend to be made far from the people that are concerned. European economic governance can only work if it is balanced and it can only be balanced if the autonomy of social dialogue and collective bargaining are fully respected.