High-Wage Germany Rebounds; On Declining Unit Labor Costs Employee concessions lifted competitiveness; exports remain crucial

Investor's Business Daily

FRONT PAGE NEWS; Pg. A01

REINHARDT KRAUSE

Germany Inc. has its groove back.

With productivity up, exports soaring and business sentiment strong, the German economy is on a roll.

GDP climbed 2.7% last year, the most since 2000. Germany's unemployment is at a six-year low.

Domestic demand, the weak link in Germany's economy, has started to rebound. Higher corporate profits are driving investment in industrial machinery, and construction activity has picked up.

But consumer spending remains weak. While a spurt in hiring has lifted confidence and given more people a paycheck, existing workers haven't seen much of a gain.

That's because slower employee concessions have been a big factor in improving Germany's productivity. Falling unit labor costs have made German companies once again competitive.

Still Export Driven

Therein lies Germany's Catch-22: Slower wage gains act as yet another brake on domestic demand. To sustain its economic upswing, Germany must find a balanced growth model, analysts say.

"The German economy has increased its productivity as wages moderated, and that means greater exports," said Mauro Guillen, director of the Lauder Institute at the Wharton School of the University of Pennsylvania.

"But that also means domestic demand cannot expand quickly, especially in a country that isn't growing in population. The net effect is still good because it leads to long-term competitiveness."

Germany's powerful unions turned pragmatic as unemployment soared, peaking at 12.1% in March 2005. To save jobs, they agreed to longer hours and even wage cuts in some cases.

Average wages rose 1.4% in Germany last year. But unions are demanding more as the economy rebounds.

Germany's 550,000 chemical-industry workers recently won a 4.3% wage hike. IG Metall, the biggest labor union, has demanded a 6.5% hike for its 3.4 million members. It may settle for 4%, observers say.

A new round of bargaining probably won't derail Germany's economy, experts say.

"Although higher wage increases in the current pay rounds should slightly dampen (corporate) investment, the economic rebound will not be choked off," said Norbert Walter, chief economist at Deutsche Bank Group.

Germany Has Curbed Pay

German workers are among the world's best paid. But modest salary gains have raised competitiveness. Real wages per employee have climbed 6% since 2000 vs. 12% in
France, 18% in Italy and 27% in Spain, Walter said.

The bargaining power of Germany's unions is probably its highest in 10 years, said Ulrich Fritsche, professor at Hamburg University. "But most people do not want to endanger the boom," he added.

Jean-Michel Six, chief European economist at Standard & Poor's, expects Germany's unit labor costs to rise in 2007 and 2008, partly because of higher wage deals.
In 2003, Germany passed laws trimming social benefits and required unemployed workers to accept "reasonable" job offers.

Germany's flexi-workers -- part-time and contract temps -- make up 40% of its work force, said Morgan Stanley. Companies resist making workers permanent because of tough rules on benefits.

"After five years of stagnation, domestic demand in Germany picked up last year," said Walter.

He said it contributed more than 1.5 percentage points to 2006 GDP growth of 2.7%.

The Institute for the World Economy has upped its 2007 GDP forecast to 2.8% from 2.1%.

Good signs abound for Germany's economic outlook.

** Productivity rose 2% in 2006, up from 1.3% in 2005 and an anemic average of 0.7% from 1998 to 2004. Unit labor costs have fallen 13.4% since the end of 2001 vs. a 7.7% gain in the U.S.

** Germany's exports shot up 12.5% in 2006, the best since 2000. Exports to China and
Russia jumped almost 25%, said the German Federation of Foreign Trade.

** Corporate profits are healthy. For the 30 companies listed on Germany's DAX stock index, analysts expect a 23% hike in earnings in 2007 compared with 20.3% last year.

The DAX has climbed nearly 30% over the past year to its highest levels since November 2000.

German banks, chemical firms, energy producers and insurers have been performing well.

** In March, unemployment hit a six-year low of 9.2%. It may fall to 8.8% by year-end, said the Institute for the World Economy.

Germany jacked up the value-added tax on sales to 19% in January from 16%, raising concerns that consumers would pull back. But retail sales stayed strong.

"German growth this year is once again likely to be much stronger than the consensus expects," said Juergen Michels, director of economic analysis for Citigroup in London.

He pegs Germany's GDP growth at 2.5% in 2007, a tad lower than last year, because of the first-half impact of the sales tax hike.

The government's move to raise the sales tax drew criticism. But Germany recently cut corporate taxes from 38.6% to 29.8%. That's closer to the European Union average of 25%.

Many economists expect Germany's exports to slow in 2007 because of the euro's strength. Walter expects exports to rise 9% this year.

Ulrich said Germany is enjoying strong emerging market demand for its capital equipment.

Some analysts contend Germany remains too reliant on exports. If global growth cools, Germany could get a cold.

Others think Germany has turned the corner. "The German economy probably won't grow as fast as it did in the mid-'80 s, prior to reunification, but the expansion is sustainable," said Jay Bryson, an economist at Wachovia Bank.

"Companies are more profitable because they have restructured and the labor market is more flexible."

April 9, 2007