Wednesday, August 01, 2007

Germany's Employment Connundrum

German unemployment has again fallen this month, and quite significantly:

The Federal Labour Agency said the number of jobseekers was down by a seasonally adjusted 45,000 last month, against economists’ expectations of a 30,000 fall, putting the jobless rate at 9 per cent. Internationally comparable figures calculated by the German statistical office using the more restrictive International Labour Office definition put the rate at 6.3 per cent in May. The new data brought the total fall in unemployment over the past 12 months to 671,000 and well over 1m since the start of the labour market recovery about two years ago. Employment showed an equally healthy picture, with 41,000 jobs created last month.

This is evidently very good news, but how do we interpret this data? Well with some caution I would argue. This is not, however, the normal response. Bertrand Benoit in the FT article linked to above is not atypical in this sense.

Benoit is almost gleeful:

The rapid fall in unemployment, long the most visible symptom of the “German disease”, has also proven wrong the doomsayers who said the country faced a future of growth without job creation.

He does, however, qualify this statement by pointing to Germany's evident structural dependence on exports:

Yet separate releases on Tuesday underscored what economists see as Germany’s vulnerable spot: its dependence on foreign markets.

Retail sales were up just 0.7 per cent in June against expectations of a 1.2 per cent rise. That followed a 2.5 per cent drop in May. Sales in the first half of the year were weaker than in the same period last year.
(See my post on this yesterday.)

As Benoit notes the "dichotomy between anaemic consumption and vigorous exports could spell trouble later this year as German exporters felt the impact from slowing demand in the US and the euro’s rising exchange rate" however, he then goes on to approvingly quote Gilles Moec, a senior economist at Bank of ­America, who says:

“We could see some wobbling in the second half, although we are confident about the six-to-nine-month horizon as we expect consumption to grab the baton from exports in supporting growth.”

So the real issue here is whether we might see anything more than "wobbling" here, and whether there are any reasons to question whether domestic consumption will in find resurrect itself and finally "take up the baton".

Well, in order to try and clarify what exactly is happening, and given a handy pointer by the Economist (who had a fairly useful article on the German labour market here), I went over to the Bundesbank, and started to consult their monthly reports.

What I found in the May 2007 edition was the following:

The situation in the labour market continued to improve at a rapid pace during the first few months of 2007 in the wake of the cyclical upturn. Employment rose once again, and unemployment showed a marked fall. The mild weather conditions also played a part in this favourable development. The number of persons in employment in the first quarter of 2007 rose by a total of 175,000, or 0.4%, to a seasonally adjusted 39.45 million. The year-on-year increase went up to around 570,000, or 1.5%, primarily in the form of employment subject to social security contributions. In particular, enterprises in the labour leasing sector, which accounted for just under half of the growth, stepped up their recruitment of new employees. Preliminary estimates by the Federal Employment Agency indicate that other forms of employment, such as low-paid part-time employment (mini jobs), activities in connection with job creation measures and employment opportunities (one-euro jobs) as well as assisted selfemployment have become less significant. Data on short-time working are not yet available for the first quarter. This form of employment is, however, likely to have increased again somewhat temporarily owing to the introduction of seasonal short-time working benefits in the construction sector. This is suggested in any event by the data for December 2006, according to which almost 30,000 more persons were receiving benefits than in November.

There was a further perceptible decline in the official unemployment figure in the first quarter. At a seasonally adjusted 3.91 million, there were 287,000 fewer persons registered as unemployed than in the final quarter of 2006. The year-on-year decline widened to 820,000 persons. At 9.4%, the seasonally adjusted unemployment rate was 0.6 percentage point down on the quarter. Within the space of a year, the unemployment rate had gone down by a substantial 2.1 percentage points.

However, the decline in unemployment in the first quarter of 2007 is likely to have overstated the cyclical influence and the mediumterm trend somewhat. Both the favourable weather conditions and the introduction of seasonal short-time working benefits are likely to have had a certain mitigating effect. The pick-up in the labour market in the second quarter could therefore be somewhat weaker than usual. At all events, there was barely any further decline in seasonally adjusted unemployment in April and the unemployment rate remained virtually unchanged on the month at 9.2%. It is also important to remember that, for demographic reasons, the labour supply is currently decreasing, which means that the fall in unemployment appears to be greater than the increase in employment. This is also due in part to the fact that the Federal Employment Agency is continuing to adjust the unemployment statistics.


The 2007 pay round began in March with wage agreements in the chemical and construction industries. The metal-working and electrical engineering industries followed in May. Firstly, the negotiating partners in the chemical industry agreed on an increase in basic salaries of 3.6% starting from the second month of the term of the agreement, which runs for a period of 14 months. A flat-rate payment of 370 will be made in the first month, and a supplementary 0.7% of a month’s salary for each of the remaining months of the contract. In the construction industry, the negotiating partners agreed on a 12-month pay settlement with no increase in the first month followed by a 3.1% increase in the standard monthly remuneration. Additionally, monthly one-off payments of 0.4% of a single month’s salary are to be made. Owing to the objections of some regional employers’ federations to the outcome of the negotiations, however, a conciliation process has now been initiated. Moreover, the pay agreement in the construction sector, which has not yet been accepted, does not affect the existing minimum wage agreement, which is still valid until the end of August 2008 and which provides for an increase in wages and salaries of 1% as of 1 July 2007. The special payments negotiated in the chemical and construction industries can be modified or completely cancelled at individual firm level by alternative agreements. Pay in the metal-working and electrical engineering industries is to be increased by 4.1% as of June 2007. This is to be followed by a further increase of 1.7% in June 2008. A one-off payment of 3400 has been agreed for the first two months of the wage agreement, and one-off payments of 0.7% of a month’s salary for the final five months. The scheduled increases and special payments from June 2008 may be deferred by up to four months at the individual firm level. The wage agreements in the major industrial sectors are a reflection of the cyclical improvement in the trade union’s bargaining position resulting from above-average capacity utilisation and ample reserves of orders. It is also a question of giving employees a fair share of the reward for the enterprises’ economic success, which has become possible not least owing to the wage restraint of the past few years. Pay agreements in the craft trades were much more moderate than in industry. A negotiated wage increase of 2.5% was agreed in the motor vehicle trade of the Federal State of North-Rhine Westphalia as well as a one-off payment of 350 for the first month of the 12-month wage agreement. In the electrician’s trade, agreement on a 2.4% wage increase was also reached in North- Rhine Westphalia (effective as of 1 February 2007) after 34 months without a pay rise.

Wages are to be increased by a further 2.2% one year later. Similar agreements were also reached in other wage-bargaining areas. According to the Deutsche Bundesbank’s pay rate statistics, negotiated rates of pay in the first quarter of 2007 were 0.8% up on the year, compared with +1.8% in the final quarter of 2006. The latter figure was primarily attributable to the one-off flat-rate payment for Volkswagen employees to compensate for the increase in weekly working hours. Furthermore, there were one-off payments in the chemical industry and in the metal working industry in the first quarter of 2006, which were not repeated on this scale. Excluding one-off payments, negotiated rates of pay went up by 1.2% in the first quarter of the 2007, compared with 1.6% in the final quarter of 2006, when public sector banks paid a Christmas bonus which compensated for the lack of holiday pay.

Construction Costs

Following the continuous rise in the cost of construction services over the past few years, prices went up by no less than 4.3% in the first quarter of 2007, and the year-on-year rate of increase widened to 7.7%. There were price rises on this scale in virtually all subsectors of construction. This surge in construction prices is attributable to the VAT increase on 1 January 2007 and the sharply increased prices of intermediate goods. Added to this was an exceptionally high level of utilisation of machinery and equipment. Construction industry capacity has been run down in recent years, which means that the increasing recovery in demand for construction work is now encountering a scarcer supply. Furthermore, labour cost pressure, which has been moderate up to now, is likely to intensify somewhat against the backdrop of the recent wage agreement. A rise in construction prices, especially in residential construction, is usually also reflected – with a certain time lag – in the prices of older buildings and housing rents. Nevertheless, the fact that land prices are virtually unchanged is continuing to have a dampening effect.

Consumer Prices: VAT perciptible effect

In the first three months of this year, the rise in consumer prices, at a seasonally adjusted 0.6%, was distinctly sharper than in the preceding months. The year-on-year increase in the national consumer price index (CPI) went up from 1.3% in the fourth quarter of 2006 to 1.7% in the first quarter of 2007. This corresponding figure for the Harmonised Index of Consumer Prices (HICP) was 1.9%, compared with 1.3% at the end of 2006.

One reason for the sharp rise in prices, despite the fact that crude oil cost less on average, was that consumer energy prices rose by 2.3% on the quarter and 2.4% on the year. This was due chiefly to the increase in the standard rate of VAT from 16% to 19%, which took effect on 1 January 2007. The higher level of VAT also had a clear impact on the other components (for more information, see the initial results of a macro data analysis on pages 52-53). The cost of industrial goods (excluding energy and tobacco products) increased by a seasonally adjusted 0.5% in the first quarter of 2007, and the year-on-year figure went up from 0.6% to 1.4%. The effect of VAT on prices in the first quarter of 2007 was particularly marked in the case of motor vehicles; the year-on-year rate of price increase widened from 1.1% to 3.0%. There was an interruption in the downward price trend for household appliances. The cost of services (excluding housing rents) increased by a seasonally adjusted 0.8% on the quarter. The corresponding year-on-year rate doubled to 2%, a part in this also being played by the increase in insurance tax from 16% to 19%. As a consequence, insurance premiums were up by an average of 2.6% on the year. Significant VAT effects were apparent in the prices of hairdressing and motor vehicle repairs, for example.

In assessing the overall impact of the VAT increase, there arises the problem that price adjustments are made for other reasons as well at the same time. Therefore, the “normal” price rise excluding VAT has to be deducted from the overall price increase. In the case of the two subcomponents of goods (excluding energy and tobacco) and services (excluding housing rents), it may largely be assumed that the price trend excluding VAT would have been much the same as in the previous two years. In the absence of more detailed information, it would appear reasonable to assume that, in the case of energy, the VAT increase was passed on in full. According to this calculation, the higher rate of VAT contributed around 0.6 percentage point to the quarter-on-quarter rate of increase in the national consumer price index (CPI) and just under 0.8 percentage point to the HICP increase. 2 This increase came on top of advance price adjustments last year, such as the increase in tobacco prices of just under 5% in October. There were also indications of accelerated price adjustments in the case of other goods, such as cosmetics and clothing. If these anticipatory effects are added to the price effects in the first quarter of 2007, the overall contribution of the higher rate of VAT to the year-on-year CPI increase is roughly 1 percentage point.3 The figure is likely to be somewhat higher for the HICP. The price effect of the VAT increase was thus considerable, but smaller than the mathematical effect of a direct full pass-through of 1.4 percentage points to the CPI and 1.6 percentage points to the HICP. Two factors need to be taken into consideration in this context. One is that a reduction in social security contributions in January 2007 provided relief to enterprises. The other is that it may be assumed that there will be further lagged VAT-induced price adjustments in the course of 2007.

1 comment:

Anonymous said...

There exists a Phillips curve for Germany, which is different from its conventional form. It says the following story - decreasing unemployment results in increasing inflation.
I put some figures together in my post