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Income Distribution in Germany and Sovereign Debt Crises

During the (economic) unification after 1990, Germany faced several challenges. A central problem was the high unemployment rate which forced the government to implement fiscal and monetary policies to reduce unemployment. Irrespective of the economic developments those measures led to stable wages, resulting in low production costs in times of economic growth in comparison to other European countries. Thus, Germany had a competitive advantage of tradable goods, leading to continuous growth of its current account surplus. A surplus generated partly on the expense of other European countries causing the European internal imbalance to enlarge, amplifying debts growth and the European crises. The foundation of income distribution for Germany’s workers and its consequences for the Sovereign debt crises will be discussed in detail.

After the German unification the country had a severe problem of unemployment with a constant rose in unemployment rate up to 10% in 1997. Facing the problem of increasing unemployment, a reverse in monetary policies led to a return to economic growth and low unemployment in the following years. Thereby, some important structural characteristics in the labor market were enforced to uncouple economic fluctuation with the unemployment rate and the wage rate. Mainly a general philosophy prevailed that makes long-term job security a priority over short- term profit making, keeping the labor market unaffected by boom-bust cycles of the world economy.

Based on this philosophy, German firms effectively kept unemployment numbers relatively lower than their production costs would normally allow by increasing working hours without additionally salary, or decreasing the number of full-time workers while increasing the number of part-time workers during times of instability.

In times of booms, instead of hiring new workers, firms motivated their workers that had already worked part-time to work longer hours, enabling firms to not encounter further training costs for new staff. Firms also rather reinvested their profits to increase their productivity to remain competitive in the world market.

German policymakers have traditionally realized to make structural adjustments that affect worker’s work-leisure patterns and their wage rate. The labor market ministry undertook a series of labor market reforms, including more experience for unemployment benefits, sanctions for refusing job offers and the development of labor agencies which allow more flexible temporary work. These measures allowed Germany to alter the work-leisure patterns of its workforce, motivating more workers to enter into temporary work and to stay in their firms to secure benefits in cases of unemployment during a crisis.

Those labor market policies undertaken by Germany’s government and the structural nature of Germany’s labor market operations, allow a stabilization of the unemployment rate, independent of macroeconomic cycles, thus keeping wages constant over time. Germany’s wage rate stayed constant despite growth-boom cycles induced by the world economy because those structural characteristics allowed German skilled workers long-term job security on a slowly increasing salary.

With the change in macroeconomic environment and the increase in GDP growth from 2000 onwards, these characteristics of the German labor market caused German firms not to hire many more workers or to increase wages excessively. This distinguished German’s income distribution from other European countries, comparing its very small increase in wages of 7.5% between 1990- 2010 with a rise of wages in e.g. Spain of 55% in the same time period. Since 2001, average hourly wages have even stagnated in real terms in Germany. Before the European debt crises, in the economic boom of 2005-2007 unemployment rates were also constant at about 9%, keeping wages rate also constant. Clearly, the comparable lower wage rates improved Germany’s competitive advantages in tradable goods keeping production costs low which result in an ever growing surplus in its current account from 2000 onwards. In addition, the repercussions of the hesitant wage rate policy in Germany is that Germany’s domestic consumer sector has always remained fairly weak with regard to its GDP, leaving spending/imports low despite economic growths. The surplus in Germany’s trade balance has been mostly based on expense of other European countries, which suffer from Germany’s advantage in production of tradable goods and it’s reserved spending pattern. With the European Monetary Union an adjustment due to nominal exchange rates in those countries were also impossible. The following statistic summarizes that Germany’s current accounts surplus mirrors the current account deficits in Southern European countries:

CA Europa

Facing the growing deficit in current accounts, Southern European countries were forced to increase their debts. A strong borrower was thereby Germany, able to invest in e.g. governments bonds in Greece and Italy with its newly generated profits. Starting from this point, as the bond market stagnated and fiscal imbalance increased, the situation for Southern European countries worsened, making it impossible to repay the high debts.

The income distribution in Germany can thus be applied to explain how the internal imbalance in Europe increased before the Sovereign Debt Crises, leading to growing debts in e.g. Southern Europe countries. The explained structures in income distribution and the low domestic spending in mind, also explains among other things why Germany has not been hidden by the recession as much as other countries and why its spending pattern has contributed to the crisis.

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Author: studentnovasbe

Master student in Nova Sbe

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