"The Strongest Horse"

The Euro zone is in a way banking on the strength of the German economy to pull it out of an economic downturn. As stated by The Economist in the September 5^th edition, “Germans are inclined, not without some pride, to see their economy as the strongest horse to pull the euro zone out of its misery.” However, there has been recent fear due to a 0.2% decrease in real output and a 1% decrease in manufacturing from the first to second quarter. This does however come with some explanation, for during the first quarter there was a mild winter which allowed for increased construction. Also, more important was the effect of the geopolitical crisis between Ukraine and Russia during this time (German exports to Russia have decreased drastically).  

Despite a poor second quarter, the overall economy in Germany is still strong. The current federal budget is almost balanced and unemployment is still low. Since the state of Germany’s economy is stable, now is a good time to start being the horse to pull the euro zone out of the hole it has dug itself into per se. Germany faces two options to do so, it can either increase investment across the board which would include both investment by companies and by the government, or increase wages. Since Russia is hindering Germany’s ability to increase investment the best option is to increase wages.

A desire to raise wages is definitely evident, for in July the president of the Bundesbank, Jens Weidman, announced that she was calling for wage increases of 3%. This increase in the minimum wages will also inadvertently cause an increase in most wage rates, mainly because it will be 40% more than the median wage. This rise in the minimum wage would mimic the “natural Hume mechanism, but with Euros instead of gold,” says Michael Burda an Economist at Berlin’s Humboldt University. Basically, what he is saying is that Germany would be copying the tactics of countries in the 18^th C that were on the gold standard who adjusted wages and prices to respond to economic imbalances. Basically Burda is saying that the euro zone has imposed a gold standard on some of its 18 members. In effect, if Germany were to let its wages rise since it is the back bone of the euro zone it could cause for an economic upturn, but if it doesn’t than the euro zone should expect to face deflation in the near future.

What is good in the case of Germany is that it does have the ability to raise wages without the economy inflating too badly, if at all. This is in part because Germany practiced wage restraint for so many years and started implementing rigorous labor-market reforms in 2003. In conclusion, unions implemented wage raises less than that of inflation and productivity growth, causing an internal devaluation. The effect of these restraints was a more competitive export market which caused workers to consume less and in turn increase surpluses. This wage raise would have a reverse effect; it would increase the overall economy, reduce surpluses, increase spending, and thus bring the euro zone relief. 

Graham Littlehale

Source: The Economist 

Edition: August 30th - September 5th 2014