ifo Viewpoint 263: Wage Negotiations in a Stagnant Economy
Wage negotiations and the demands made by both sides often spark heated debates. Take the German trade union IG Metall, for example, which is pushing for a 7% wage increase, even though the economy is flatlining. With inflation expected to be around 2%, this would mean a real wage increase of 5%. Such a demand would make sense if the metal industry were booming while the rest of the economy struggled – but that’s not the case. IG Metall itself admits that production in the sector is down 7% from last year, and orders are declining. The union argues that higher wages would boost purchasing power and overall economic demand. On the other hand, employers argue that wages in the metal industry have risen faster than productivity in recent years, and now, it’s essential to avoid jeopardizing Germany’s industrial base with unsustainable labor costs.
Will Higher Wages Boost Demand?
Wages have a range of effects on an economy: they impact purchasing power, overall demand, the willingness to work, and businesses’ demand for labor. The purchasing power argument is less relevant for wage increases in specific industries. For example, in the metal industry, which exports a significant portion of its production, domestic purchasing power plays a relatively minor role.
On a macroeconomic level, the situation is different. However, higher wages only boost demand if workers actually spend the extra money. Earlier this year, economic forecasts were based on the expectation that rising real wages would lead to increased consumer spending.
That didn’t happen. Instead, consumers saved much of their additional income. It seems people are worried about their future income prospects. This weakens the argument that higher wages will automatically boost purchasing power. In fact, if significant wage increases from collective bargaining make jobs less secure, this could even dampen consumer demand.
The Impact of Wages on the Labor Market
Higher wages also influence labor supply. When there’s a shortage of workers, better pay can help alleviate the issue. But for that to happen, rising wages need to translate into higher take-home pay. In Germany, especially for lower-income earners, that’s not always the case. As wages rise, so do taxes and deductions, while social benefits, such as housing benefit, may be reduced or lost entirely. Depending on family circumstances, more than 90% of the extra income can be eaten up by taxes, contributions, and the loss of benefits. In these situations, higher wages mostly benefit the government rather than workers, leading to frustration instead of increased motivation to work.
As for the argument that rising wages hurt competitiveness and push companies to invest abroad, that’s less relevant when there’s a labor shortage. In such cases, businesses are often willing to hire more workers at the current wage level but simply can’t find enough qualified candidates.
Wage Growth and Competitiveness
Whether wage growth endangers jobs can be gauged by comparing wage increases to labor productivity. The data shows that, on average, real wages in Germany in 2023 were actually slightly lower than in the pre-crisis year of 2019. However, productivity has also declined slightly since then. This means that wage growth in recent years, despite all the turbulence, has roughly aligned with productivity trends. Given that corporate investments are currently much lower than in 2019, it’s likely that labor productivity will continue to fall. This suggests that there’s limited room for substantial wage increases.
The reality is that in a stagnant economy, there’s little scope for wage growth beyond inflation adjustment. The idea that higher wages could boost purchasing power enough to lift the economy out of stagnation isn’t convincing, particularly since economic uncertainty tends to drive much of the additional income into savings rather than spending.
IG Metall is well aware of this. One of the historical strengths of Germany’s collective bargaining system has been the unions’ pragmatic approach during difficult economic times. While the union might start negotiations with a demand for a 7% wage increase, this doesn’t mean that’s where the deal will land. In the end, workers in the metal industry are likely to get a much smaller raise.
Clemens Fuest
Professor of Economics and Public Finance
President of the ifo Institute
Published under the title „Der undankbare Konsument“, WirtschaftsWoche, September 20, 2024.