Tuesday

19th Feb 2019

Opinion

In Europe, low wage growth isn't as bad as you think

  • In the past, low unemployment allowed workers more flexibility to negotiate pay rises (Photo: Peter Teffer)

Throughout Europe, frustration over low wage growth continues to make headlines. But a close look at the data actually disproves some of the outrage.

Unemployment has dropped throughout much of Europe. In the past, a low unemployment rate has been associated with decent wage growth. In other words, less people as 'spare capacity' on the sidelines meant more money going into employees' wallets and pocketbooks.

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As an example, consider the Netherlands. From 2004 to 2006, the country saw wages grow at an annual average of about 2.4 percent. But in the last three years of this decade, from 2014-2016, the country saw wages grow at an annual average of just 1.1 percent.

In both periods unemployment was pretty much the same. If one examines wage growth through just that measurement – unemployment – the mid-2000s clearly represented a better time for wages. And so the current anger about weak pay makes sense.

But here's what's interesting: the slow pace of recent wage growth actually appears ordinary when two more indicators get included, inflation and labour productivity growth.

Wage growth has stayed low because, in recent years, inflation and labour productivity growth have been unusually low.

Continuing the focus on the Netherlands: from 2014-2016 inflation was 0.2 percent, whereas from 2004-2006 it was substantially higher, at 1.5 percent. And from 2014-2016, productivity growth was one percent, whereas from 2004-2006 it was double, at two percent. Beyond the Netherlands, this example applies to much of Europe and thus makes some of the uproar a bit unsubstantiated.

Aside from the statistics, it helps to understand the real-world influence that labour productivity growth and inflation have on wages.

Across Europe, low levels of labour productivity growth discourage businesses from increasing worker pay. After all, output per worker has not increased.

And when it comes to inflation, businesses typically compensate workers more when prices rise. But as evidenced by the Netherlands, labour productivity and inflation have recently risen at a snail's pace; European businesses, in turn, feel compelled to compensate workers at a similarly slow rate.

A pay rise, please?

In short, wage growth in much of Europe comes in at the expected range once we account for low inflation and weak productivity growth. That being said, plenty of room exists for wages to increase. What factors might boost wages in Europe?

First, consider a further tightening of labour markets in Europe. True, the unemployment rate is still relatively high – 9.1 percent in the euro area and 11 percent excluding Germany, but this is also due to an increase in participation. More people are entering the labour market, attracted by the job openings and the return of economic growth.

If labour markets continue to tighten businesses would have eventually to increase wages to attract qualified workers, especially in some countries where unemployment is well below the average.

When it comes to boosting wages, productivity could also come to the rescue in the near future. The Conference Board's Total Economy Database shows an uptick in labour productivity growth in the euro area. While cyclical and modest, it serves as a good signal of a possible reversal of the downward spiral seen since the late 2000s.

Another important development to consider is the wage negotiations in Germany, between employers and unions.

Recently, employers have had more difficulty in finding qualified workers, as evidenced by the record-low unemployment rate of 3.6 percent. If German companies attract better skilled workers by offering higher wages, it might set the stage for other countries to follow in their footsteps and reverse the trend of 'internal devaluations' – keeping labour costs down to outcompete neighbouring markets.

Finally, wage growth will enjoy a bump from something that might surprise some: the ageing of Europe's workforce, coupled with low entrance of youngsters into the workforce. With each passing day, Europe's working-age population shrinks as the amount of people retiring outweighs the number of young individuals entering.

About one in five western Europeans is 65 years or older; by 2030, projections expect that ratio to rise to one in four. A workforce at risk of shrinking will tighten the labour market and thus drive up wages.

Ilaria Maselli and Frank Steemers are economists at The Conference Board, a global business research organisation

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