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Germany's economy

Watching the wages

Germany's economy stutters, even if the fundamentals are strong

BLAMING Germany—or at least the austerity prescribed for the euro zone by Chancellor Angela Merkel—for Europe's ills may be popular in France. But Germans are inclined, not without some pride, to see their economy as the strongest horse to pull the euro zone out of its misery. Hence the fear caused by a surprising update this month: real output shrank by a seasonally adjusted 0.2% in the second quarter from the first, and manufacturing by 1%.

Part of the explanation was statistical. Thanks to a mild winter, there was more construction than usual in the first quarter. But geopolitical crises, especially in Ukraine, had a bigger impact. German exports to Russia have plummeted. Given the timing, the drop was due less to sanctions already imposed than to expectations of more to come. Russia accounts for only 3% of Germany's total trade, so the losses were easily made up in higher exports elsewhere. More devastating is the rising uncertainty over Russia that is causing managers to delay investment. Germany's Ifo business-climate index, a widely watched benchmark, fell in August.

Aside from such new risks, however, the underlying German economy still looks strong. The federal budget is close to balance. Unemployment remains low: indeed, labour shortages are an increasing problem. This applies to large businesses such as care for the elderly, but especially to many of the niches for which Germany is famous, such as hearing-aid acoustics, according to the Cologne Institute for Economic Research.

Germany's best contribution to recovery in the euro zone would be to let wages rise. Whether they are already doing so will not become clear for months, because Germany reports the relevant statistics more slowly than most. But the willingness is there. In July Jens Weidmann, the president of the Bundesbank, Germany's notoriously hawkish central bank, caused a sensation by calling for pay rises of 3% on average. A new minimum wage should also nudge wages up. It will take effect in 2015 at 8.50 an hour, more than 40% of the median wage.

Rising German wages would represent the “natural Hume mechanism at work, but with euros instead of gold,” says Michael Burda, an economist at Berlin's Humboldt University. By this he means the process first described by David Hume in the 18th century, under which countries on the gold standard adjusted to imbalances not by letting currencies appreciate or depreciate but through rising or falling prices and wages. In effect, Mr Burda says, the euro zone has imposed a gold standard on its 18 members. Prices and wages are falling in several crisis countries. Germany could help by letting its wages rise—if it is willing to accommodate this. If not, there is a serious risk that deflation could take hold across the euro zone as a whole.

German firms certainly have plenty of leeway, after practising wage restraint for the past decade. Known as the sick man of Europe ten years ago, Germany underwent a set of wrenching labour-market reforms starting in 2003. Unions co-operated meekly, often accepting wage rises below inflation and productivity growth. In effect, this was an internal devaluation that made exports more competitive, especially in sectors such as machines and chemicals, according to Karl Brenke at the German Institute for Economic Research in Berlin. The forgone spending power by workers also depressed consumption. The combination led to huge trade surpluses.

Rising wages and consumption in Germany, if they are accepted, would partially reverse this trend. That would lead to smaller trade surpluses, as both the European Union and the Americans are demanding. The only other domestic lever is increased investment, both by the government and by companies, an area where Germany has been stingy in recent years. But because investing requires confidence, Russia is again proving a damper.