Search This Blog

Thursday, 7 January 2016

About anaemic inflation in the Euro-zone, flexibilization of the labour market and the real wage increases since the start of the economic crisis

“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:
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:
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:
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:
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:
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:
Click to enlarge

The correlation between wage development
and inflation data in The Netherlands
Chart by: Ernst's Economy for You
Data courtesy of:
Click to enlarge

The correlation between wage development
and inflation data in Spain
Chart by: Ernst's Economy for You
Data courtesy of:
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.

No comments:

Post a Comment