This opinion piece was published in Caixin and Caixin(English).
Jamaica has failed: the negotiations to form a new government in Germany by the so-called “Jamaica” partners, named after the colours of the parties that are the colours of the Jamaican flag – black, yellow and green, were ended by one of the small partners, the liberals. The breakdown came as a surprise to many and was certainly a shock to the Berlin political establishment: it is quite unusual for Germany to take such a long time to negotiate the formation of a new government.
Yet, commentary that Germany has entered a “crisis” is wrong and exaggerated. For a start, the political negotiation for a different majority have already started. As this column is written, it is possible that the same partners of Angela Merkel’s previous government will find together again. This would bring a continuation of the current approach, an overall centrist government. The government will certainly be pro-European. Yet, a coalition between the two largest parties is also going to be bad for the political discourse as Germany’s right wing party will become the largest opposition party. This is one of the reasons why many in the social democratic party still strictly reject the option. So indeed, it cannot be taken for granted that a new government will be formed without a new elections.
However, the talk of crisis misses the extraordinarily benign situation of Germany, which also allows to make political compromises easier. The budget situation is certainly strong. Germany’s overall state runs a fiscal surplus of around 30 billion euros, which is almost 1% of GDP. The rules governing Germany’s fiscal policies would not require more than a balanced budget. So there clearly is room for tax cuts and/or new spending that will make new political agreements possible.
More important than the government sector is the improving situation in Germany’s labour market. The unemployment rates have been falling substantially in the last decade, while participation in the labour market has increased. In other words, overall employment is at a record high.
Yet, German wage dynamics have been rather disappointing over the last 15 years. Wages have been going sideways and this has created some political and social tensions. The slow wage growth has also resulted in some nervousness in other parts of Europe and at the ECB. If wages don’t grow much despite low unemployment, has the relationship between unemployment and wages and inflation broken down?
A break-down of the so-called “Philips-curve” would be particularly problematic in the euro area. In particular, the euro area needs to see inflation rates that differ across different parts of the euro area so that adjustment dynamics can play their full role. In particular, stronger countries with tighter labour markets should see higher inflation rates than weaker countries with higher unemployment rates. That means that German wages and inflation should now grow more rapidly than Italian or French ones.
So the fear in Europe was that German wage inflation was perhaps not following the typical reactions to unemployment anymore, making growth and adjustment in the entire euro area more complicated.
Recent data appear to prove those fears unwarranted. The tighter labour market is gradually also leading to stronger increases in wage agreements in collective wage bargaining. One important example are the recent demands by the metal unions, the IG Metall, to increase wages by 6% – a sizeable increase in an environment of less than 2% inflation and around 1.5% productivity growth. These demands were combined with demands for more flexibility on working hours. The increased demands are also starting to be visible in the economy-wide collectively agreed monthly earnings in Germany, where actual yearly earning have significantly increased to almost 4%.
These recent wage increases happen against the backdrop of significant immigration. Beyond the many refugees that often do not enter the labour market quickly, immigration from other EU countries has been increasing substantially and exceeds 300,000 per year in net terms. Gross immigration is now above 900,000 from the EU – a substantial number given the population size of 82 million. A large part of these EU migrants actually enter the German labour market – adding new productive capacities and tax revenues.
Despite the strong numbers and the improving situation: the future German government will have to take important decisions to ensure the long-term prosperity of the country. First, the recent real wages increases are welcome but the last ten years have resulted in lower income shares going to middle-class workers. While Germany has overall a rather low income inequality, the government will still have to ensure that social tensions do not increase. This is all the more important in a situation in which immigrants are perceived as a threat to the social cohesion of the country. It is an important priority to boost investment and tackle inequalities. Second, while Germany’s economy is leading in industrial production, industry 4.0 and the use of artificial intelligence in industrial processes, Germany and Europe is a laggard in the data-driven, digital sector. Germany and Europe also face important security challenges and further immigration pressures. Third, Germany’s voice in the European debate is indispensable. France’s president Emmanuel Macron rightly expects an answer from Germany for his far-reaching proposals to strengthen the cohesion and collaboration in Europe.
The failure to form a new government in Germany is not a crisis nor does it affect the prosperity of the country at this stage. On the contrary, Germany is strong and healthy. Yet, important decisions for the future need to be taken – so the stakes are high for the coalition negotiations.
