Euro Crisis: German Unit Labor Cost repression is the primary cause of periphery stress


In the above graphic note that France has closely tracked the agreed EU inflation target of 2%, while Germany violated the agreement, largely by repressing wage increases (and hence Unit Labor Costs).

Heiner Flassbeck has been studying the impact of Germany’s wage deflation policy for at least six years. E.g., from 2006 he wrote:

The European Monetary Union can only function if nominal wage increases in all member countries are in line with the inflation target set by the monetary authorities. Given the close correlation of unit labor cost growth (nominal wage growth minus productivity growth) and inflation, the implicit rule of the monetary union asks for real wage growth in each member state following strictly national productivity progress and for unit labor costs not exceeding and not undershooting a 2 percent growth path in each member state.

Violations of this rule will either lead to inflation or deflation in the union as a whole or to deviations of national real exchange rates and national levels of competitiveness bearing grave long-run consequences for the appreciating countries. This kind of aberration started with the beginning of the currency union in 1999–with Germany, due to its deflationary wage policy, being the main culprit. Without fundamental changes in wage policies throughout Europe, a deflation or a transfer union, comparable to the German transfer union after unification, is an imminent danger.

That quote is from “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?

A much more detailed investigation is in Intereconomics vol 46, 2011, Flassbeck and Spieker, The Euro – a Story of Misunderstanding.

From the very beginning of the European Monetary Union the crucial institutions, the European Commission and the European Central Bank, led by mainstream economic thinking, were not up to their task of controlling the core of the system effectively. A huge gap in competitiveness among the member states has arisen due to German wage-dumping policy on the one hand and, on the other, wage growth in Southern Europe which is above the growth of productivity plus the infl ation target of 2%. A European-wide coordination of wage policy is the only promising way to close this gap. However, as wages and competitiveness are not high on the agenda of the politicians responsible and their advisers, time to save the euro is running out.

For another perspective on the same core problem, see Michael Pettis “If no trade reversal now, then when?“. Prof. Pettis puts it this way:




I highly recommend a careful read of both Pettis and Flassbeck.