“It
is not the cost price of goods that should decide their sales price
It
is the price that people are willing to pay for it, that matters”
Cees
van Turnhout – former CEO of Ferney Holland
In the economy there are topics, which regard to
seemingly independent measurement units. However, it makes sense that there is actually
a quite strong connection between these topics. Two of such topics are for
instance the inflation rate and the development of net earnings in an area.
In order to make my point, I want you to take a look at
inflation:
Although I don’t know the exact way in which the Dutch
and European inflation rates are calculated, I presume that this happens via a
‘basket’ of products and services.
In this basket there are probably items like:
- taxes and levies;
- (social) housing rent rates;
- interest rates on mortgages and private loans;
- ticket prices for public transportation;
- energy prices (i.e. oil, gas and electricity);
- food;
- alcohol & tobacco;
- fashion, shoewear and clothing;
- small consumption goods and household appliances;
- durable consumption and production goods;
- prices for means of transportation.
This list is probably far from complete, but it
sketches an image of what to expect in that basket.
Of course there are a number of components within this
basket of which the value (and thus the effect on inflation) is much more
dependent on the goals of the supplier than on the existing demand for this component.
Examples, for which suppliers have an extraordinary
influence on prices are:
- taxes, social
housing rent rates, alcohol & tobacco (through excise duties and levies)
and public transportation tickets: mainly national politics as ‘supplier’/
price setter;
- interest rates on mortgages and private loans: the global
financial system as price setter;
- food and commodities: farmers and producers, as well as
nature (due to natural scarcity);
- energy sources, precious metals, fertilizers and minerals: international trade markets and global politics.
These are all goods and services of which the price
elasticity is quite (in some cases extremely) low, as (most) people need these
goods and services anyway in spite of higher prices, as there are hardly any alternatives available for
it.
However, for probably most other items in the inflation
basket, there is a substantial price elasticity. People can simply decide to NOT buy
these items in times of high prices, as only few of them are really
indispensable.
Purchase of all the other items can be postponed for shorter or longer periods (f.i. until the Sale period starts, in case of clothing and shoewear). And even
when people buy such items, they can choose between cheaper and more expensive
alternatives, dependent on their mood and personal wealth situation.
It figures that when many people choose for cheaper
varieties of consumption goods and durables, this will have a strong downward influence on price
development and thus inflation.
As a wise man – Cees van Turnhout, a former executive
of mine – once said: “It is not the cost
price of goods that should decide their sales price. It is the price that
people are willing to pay for it, that matters”.
Although this expression was made in the context of durable
goods being sold too cheaply, it is also true in the context of goods being for
sale at excessive prices. This becomes clear with the following example:
When an average family has only €500 in free spending
money per month available for consumption goods, they will buy the things that
they want or need, using that amount of money alone. In normal situations, they
will not take a personal loan to increase their monthly spending money.
When the consumption goods of their desiring become
more expensive, these people will buy simply less of them, as their free
spending money does not increase. Hence: those goods will stay at about the
same prices, as either manufacturers will voluntarily waive price increases or
else cheaper alternatives will replace the more expensive ones.
So in times when the net income of average middle-class
and lower class people shows hardly any positive development, the chances for
real inflation are close to nought, unless such inflation is spurred by taxes,
changes in interest rate or changes at the international energy, food and
commodity markets.
In this case, it even does not matter much when the
total amount of money and credit in the market is strongly elevated – due to external
causes like f.i. quantitative easing – as long as this money does not trickle down to
‘Joe Sixpack’, ‘Otto Normalverbraucher’, ‘Jan Modaal’ and other average middle
and lower class citizens, where it increases his monthly free spending money.
I had to think about this when I read the following press
release from the Dutch Central Bureau of Statistics and subsequently a news
message from Eurostat about the European inflation:
Adjusted
for inflation, the average remuneration per employee has decreased after the
outbreak of the credit crunch in 2008, although labour productivity increased.
This means that the higher labour productivity level of employed persons has as
yet not resulted in a higher remuneration level for employees (after adjustment
for inflation). According to Statistics Netherlands (CBS), the high
unemployment rate and the growing number of flex workers and self-employed may
have played a part in this respect.
 |
| The decoupling of labour productivity and remuneration for employees Chart courtesy of: www.cbs.nl Click to enlarge |
Productivity
growth slows down compared to the pre-recession era
In
the period 2002-2008, the labour productivity of total Dutch economy, excluding
the sectors public administration and education, annually grew by an average of
1.6 percent. The real remuneration, i.e. adjusted for inflation, also rose
during this period, but the rise was less substantial than anticipated on the
basis of labour productivity.
In
the latter half of 2008, the recession kicked off, resulting in a sharp fall in
labour productivity caused by the fact that the input of labour and capital
could not be adjusted soon enough to the reduced demand. This appears to be a
recurrent pattern at the onset of a crisis. After 2009, labour productivity
grew by an average of 0.8 percent annually. At the same time, the real
remuneration per employee (including social contributions paid by employers)
declined by 0.1 percent annually. In 2014, however, the situation began to
change.
Unemployment
and flexibility of the labour market keep wages down
Real
remunerations decreased and simultaneously labour productivity increased. This
is caused by the fact that tension on the labour market declined considerably
after 2008. In 2013 and 2014, the number of unemployed rose significantly and
far exceeded 600 thousand. When such a situation occurs on the labour market,
employees are not in a position to make demands and there is no real pressure
on employers to raise wages.
 |
| The soaring growth in the number of self-employed and flex-workers between 2003 and 2015 Chart courtesy of: www.cbs.nl Click to enlarge |
Another
reason for the fact that wages are falling behind is the growing number of
flexible employment contracts. The number of permanent employment contracts is
being reduced and replaced by more flexible types of employment contracts.
Since 2009, wages of flex workers have been lower than wages of employees
working on permanent contracts. The number of self-employed, especially
self-employed without personnel, may also have had a negative effect on the
wage level of employees. Incomes of self-employed are not included in
remunerations. To what extent the growing number of self-employed affects the
remuneration level of employees remains unclear.
This news from CBS about the structural decoupling between
productivity growth and wage growth in The Netherlands is not surprising by
itself. Yet, it is a tell-tale signal about how wage
restraint and its ugly brother wage reduction, as well as the ubiquitous flexibilization of the labour market have nibbled away purchase power from
the Dutch middle class and lower class workers.
In spite of their annually increasing productivity
since at least 2002, the workers mostly did not received the justified
remuneration for this.
As a matter of fact, for younger workers the fixed job contract
has nearly been sacrificed in favour of payrolling, temporary labour contracts,
temporary assignments through temp agencies, zero hour contracts and freelance contracts.
These are all contracts that all offer only a little amount of security for the
workers and – on top of that – make it very hard for young workers to demand
higher wages, as the CBS press release already stated.
This situation is far from unique for The Netherlands;
to the contrary, this phenomenon can be seen everywhere in Europe.
To these eyes, this flexibilization of the labour
market and the decoupling between productivity growth and wage growth are two
of the reasons that it seems impossible to bring the inflation back to the “close
to, but not quite 2%” inflation as desired by the ECB. Therefore both circumstances
lay considerable downward pressure on the inflation rates.
The moral side of it is that middle and lower class
workers simply don’t receive enough wages and salaries for their efforts and
don’t see their purchase power increase, in spite of their increased
productivity.
So when there is not an inflationary trend in either the
energy prices or the food prices and when the wages and net earnings do also not
increase at the same time, the chances for considerable inflation are that of a
snowball in hell!
This is proven once again by the latest inflation data from
Eurostat. The following snippets are from the Algemeen Dagblad:
The
inflation in the Eurozone was 0.2 percent year-on-year in December 2015. In November
the inflation had been at the same level. The inflation is still under the
desired rate of ‘close to, but not quite 2%’, which is strived for by the ECB.
This was the reason that the ECB announced additional measures at the beginning
of December.
In my humble opinion, the ECB can say and do what it
wants, but before the wages of lower class and middle class workers become
considerably higher, the inflation will not go anywhere, as far as I’m
concerned.
To prove my point, I collected the monthly inflation
data (2005 – November 2015) for six countries in the old Euro-zone – France,
Italy, Spain, Belgium, Germany and The Netherlands – for the categories Energy,
Food and Miscellaneous (all other categories, except for Alcohol & Tobacco).
I also took the annual wage development data for these
countries between 2005 and 2014 for four of the most occuring household types
and made one data set from it, with the unweighted average wage development of all
these household types combined.
In order to make both data ranges comparable, I interpolated
the annual wage data over the months of these years and I also extrapolated the
2014 wage data upon 2015 [wage data for 2015 was not yet available – EL]. I know that all these
aforementioned changes could be called ‘tweaking’, but otherwise it would be
impossible to compare both data sets in an understandable way.
I created these charts, as I wanted to check my
statement that the inflation for consumer goods and durable goods with high
price elasticity, will be close to nought when the net earnings of households
don’t increase.
 |
| The correlation between wage development and inflation data in Belgium Chart by: Ernst's Economy for You Data courtesy of: ec.europe.eu/eurostat Click to enlarge |
Belgium is one of the few countries where the indexed
wages (red line)
between 2005 and 2015 have actually risen considerably. Except for the
categories with low price elasticity Energy and Food, there has not been a
considerable inflation for the other categories. Particularly in Belgium, one
can see clearly that the dropping energy prices of 2015 will have a strong downward
effect on the Belgian inflation rate.
 |
| The correlation between wage development and inflation data in France Chart by: Ernst's Economy for You Data courtesy of: ec.europe.eu/eurostat Click to enlarge |
Wage development between 2005 and 2015 has been
virtually non-existent in France. Also here the only really inflatory
influences have been the energy and food prices between 2005 and 2015, while
the price development of other consumer goods and durables has been very
moderate, as I would expect.
When oil or food prices will not increase dramatically
in the coming year, the odds for a 2% inflation in France seem close to nought
with the development of wages there.
 |
| The correlation between wage development and inflation data in Germany Chart by: Ernst's Economy for You Data courtesy of: ec.europe.eu/eurostat Click to enlarge |
Also in Germany, the wage development has been anaemic
during the last ten years, due to a policy of wage restraint and
flexibilization of the labour market. Again here, energy and food have been the
only real triggers for inflation, while the price development of other goods
and durables has been very moderate indeed.
 |
| The correlation between wage development and inflation data in Italy Chart by: Ernst's Economy for You Data courtesy of: ec.europe.eu/eurostat Click to enlarge |
 |
| The correlation between wage development and inflation data in The Netherlands Chart by: Ernst's Economy for You Data courtesy of: ec.europe.eu/eurostat Click to enlarge |
 |
| The correlation between wage development and inflation data in Spain Chart by: Ernst's Economy for You Data courtesy of: ec.europe.eu/eurostat Click to enlarge |
In Italy, The Netherlands and Spain the same trends were
visible: wage development between 2005 and 2015 being close to nought, while
energy and food were nearly the only triggers for inflation. Inflation for all the other categories has developed very moderately, in correlation with the anaemic wage development.
Therefore the
conclusion of this article can only be: if the ECB really wants to spur
inflation in the Eurozone, it must emphasize to the European Council that the
wages and remuneration of lower and middle class workers must go up
considerably, with at least 3%-4% annually for a period of five to ten years.
Otherwise, all attempts to spur inflation will be futile: quantitative easing or not!
In order to
achieve this, there are two roads ahead:
- First, companies must pay higher wages to their steady workers in the bottom half of the organization.
- Second, companies must stop with forcing the hourly rates and payments down for their flexible workers and freelancers. Instead, they should pay these workers a fair remuneration and they should also increase their labour security .
When this will
not happen, we will firmly remain in deflation territory, as we have been the
last few years, when energy and food would have been taken out of the equation.
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