During the 1990s, German workers’ real (inflation-adjusted) wages rose along with productivity gains, meaning that employers could pay the higher wages without facing higher labor costs per unit of output. After 1999, wage gains no longer kept pace with productivity, and the gap between the two widened. As wages stagnated, inequality worsened, and poverty rates rose. Total labor compensation (wages and benefits) fell from 61% of GDP in 2001 to just 55% of GDP in 2007, its lowest level in five decades.
German wage repression went even further than necessary to meet the 2% inflation target mandated by the eurozone agreement, and insisted upon by German policymakers. Unit labor cost (workers’ compensation per unit of output) is perhaps the most important determinant of prices and competitiveness. Unit labor cost rises with wage increases but falls with gains in productivity. From 1999 to 2013, German unit labor cost increased by just 0.4% a year. The reason was not German productivity growth, which was no greater than the eurozone average over the period; rather, it was that German labor-market policies kept wage growth in check.
This combination of a built-in system of currency manipulation afforded by the euro and labor-market policies holding labor costs in check turned Germany into the world’s preeminent trade-surplus country. As its competitive advantage grew, its exports soared. Germany’s current account surplus became the largest in the world relative to the size of its economy, reaching 7.6% of the country’s GDP, more than twice the size of China’s surplus compared to its GDP.
Germany’s transformation into an export powerhouse came at the expense of the southern eurozone economies. Despite posting productivity gains that were equal or almost equal to Germany’s, Greece, Portugal, Spain, and Italy saw their labor costs per unit of output—and in turn prices rise— considerably faster than Germany’s. Wage growth in these countries exceeded productivity growth, and the resulting higher unit labor costs pushed prices up by more than the eurozone’s low 2% annual inflation target (though by only a small margin).
The widening gap in unit labor costs gave Germany a tremendous competitive advantage and left the southern eurozone economies at a tremendous disadvantage. Germany amassed its ever-larger current account surplus, while the southern eurozone economies were saddled with worsening deficits. Later in the decade, the Greek, Portuguese, and Spanish current account deficits approached or even reached alarming double-digit levels, relative to the sizes of their economies.
In this way, German wage repression is an essential component of the euro crisis. Heiner Flassbeck, the German economist and longtime critic of wage repression, and Costas Lapavistas, the Greek economist best known for his work on financialization, put it best in their recent book Against the Troika: Crisis and Austerity in the Eurozone: “Germany has operated a policy of ‘beggar-thy-neighbor’ but only after ‘beggaring its own people’ by essentially freezing wages. This is the secret of German success during the last fifteen years.”
While Germany’s huge exports across Europe and elsewhere created German jobs and lowered the country’s unemployment rate, the German economy never grew robustly. Wage repression subsidized exports, but it sapped domestic spending. And, held back by this chronic lack of domestic demand, Germany’s economic growth was far from impressive, before or after the Great Recession. From 2002 to 2008, the German economy grew more slowly than the eurozone average, and over the last five years has failed to match even the sluggish growth rates posted by the U.S. economic recovery. With low wage growth, consumption stagnated. German corporations hoarded their profits and private investment relative to GDP fell almost continuously from 2000 on. The same was true for German public investment, held back by the eurozone budgetary constraints.
At the same time, Germany spread instability. Germany’s reliance on foreign demand for its exports drained spending from elsewhere in the eurozone and slowed growth in those countries. That, in turn, made it less likely that German banks and elites would recover their loans and investments in southern Europe.