Rui Soares is an investment professional for FAM Frankfurt Asset Management, an independent investment firm.
Several news outlets, including the Financial Times, have drawn attention to the threats of strike action coming from German workers. The press’s knee-jerk reaction to these threats has been to link them to the recent rise in inflation, which has seen prices climb 4.1 per cent over the past 12 months.
And at first glance, the workers’ actions may indeed look like a direct reaction to price pressures. But a closer look reveals a more chronic problem: decades during which Germany’s workers have failed to (fully) reap the gains of euro membership.
German businesses have benefited greatly from the euro’s creation more than those in other countries. Having a currency that is fairly valued for the eurozone as a whole doesn’t mean that the currency is fairly valued for each member country. For Germany, euro area membership has produced 20 years of undervalued currency — as a string of current account surpluses testify.
But the evidence of the single currency’s benefits for German society as a whole is less substantial.
Before euro membership, there was of course the Deutschmark. Contrary to conventional wisdom, appreciations of the German currency didn’t lead to significant drops in exports. During such periods, exports just grew at much lower rates or remained stable. The reason being that German companies mostly produced high-value-added products with a reasonably low price elasticity of demand (a 10 per cent price increase didn’t, and still doesn’t, lead to a complete collapse of demand for BMWs).
These appreciations did, however, produce a strong rise in imports. Which suggests the German consumer was able to take advantage of appreciation to buy more goods and services from the rest of the world. And that in turn means that appreciation weighed on corporate profits, not wages.
The Deutschmark’s international prowess was, therefore, a massive income redistribution mechanism. Appreciation took from the wealthiest in German society (business owners, top management, shareholders in general) and gave it to the middle class (employees). Any increase in Germany’s international competitiveness that occurred at the expense of workers was short-lived, as the current account surplus that resulted would in turn lead to a further currency appreciation that would redistribute income towards workers.
But the pre-Eurosystem system had a mechanism to balance the interest of workers and capital that the current system lacks.
Here’s a quick way to quantify this statement. The net profits of the DAX 30 companies have increased on average by 8.1 per cent a year since 2004 (I use 2004 as starting point to avoid the distortions that the bursting of the internet bubble in the early years of euro adoption would cause to the calculations). This compares with just 1.5 per cent for France’s CAC 40, 0.2 per cent for the Euro Stoxx 50 and declining net profits of 2.4 per cent per annum for the Italian FTSE MIB and 1.9 per cent for Spain’s IBEX 35. All brilliant news for shareholders of German companies and their top management. However, nominal wages for workers over the same period increased by less than 3 per cent a year.
No matter what government coalition ends up running the country over the coming four years, a new era is about to begin. And an important topic will, alongside climate change, dominate the German political agenda for years to come: social inequality. The increasingly heated debate about how to stop the social divide in the German real estate market – well-off landlords benefiting from rising real estate prices versus middle class tenants being squeezed by higher rents – is a clear indicator of where things are heading.
According to the latest surveys by polling firm Civey, a majority among the German economic elite prefers a coalition dominated by left-wing parties. Forty-five per cent support an “Ampel” coalition, compared with the 30 per cent that are in favour of a “Jamaica” coalition that would keep the centre-right CDU as the country’s leading party. That suggests the social inequality debate may have reached German corporate boards, and top managers are aware of the need to deal with the topic. At this stage, the only open question is how to strike a better balance while remaining in the euro area. One way or another, the average German will likely see their real income over the coming years rise more strongly than in the past two decades.
Yet this is not to say that German workers’ wage demands will trigger a wage and price spiral that will lead to ever-higher inflation across the currency bloc.
France’s unemployment rate is 8 per cent, Italy’s 9.3 per cent and Spain’s 14 per cent. The three countries together account for half of the eurozone’s economic output. Combine the substantial slack in the eurozone’s labour market with the free movement of people, capital, goods and services, and one would imagine that German companies will struggle to pass on those higher labour costs to consumers elsewhere.
Better wages for German workers will also have the effect of raising imports, narrowing the current account surplus and boosting economies across the region in the process.
What the Deutschmark did automatically, German workers must now do themselves. Doing so will be to the benefit of the entire region.