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Graph of the week

Graph of the week

22-03-2019 | Insight

Disappointing wage growth

  • Peter van der Welle
    Peter
    van der Welle
    Strategist

The tightness in the labor market is rising steadily, with demand outstripping supply. In the current pro-longed economic expansion, this situation has now become a worldwide phenomenon. Last week's NFIB survey in the US, for example, indicated that not only the big players but also medium- and small-sized companies are really struggling to fill vacancies. The competition between companies to attract suitable employees has pushed up wages in the country by 3.4% (YOY) in the past year. 

We are also seeing tightness on the European continent, with German companies in particular experiencing labor shortages as a bottleneck for further growth. Wage growth in Europe now stands at 2.4% (YOY). But, while it’s logical that this situation is boosting workers’ bargaining power, how much wage growth should we actually expect in the Eurozone given the tightness? The graph below gives the answer. 

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Source: Thomson Reuters Datastream, Robeco

The green line is a regression analysis that attempts to explain the actual wage growth by looking at a tightness indicator for the Eurozone labor market. This tightness indicator is the difference between actual unemployment in the Eurozone (currently 7.9%) and equilibrium unemployment (which the OECD estimates at 8.1%). A tight labor market can be defined as a market in which actual unemployment has fallen below equilibrium, long-term unemployment.

No overheating

It is interesting to see the 2.4% wage growth in the Eurozone, shown by the turquoise line, is currently below what you would expect purely on the basis of the model (2.8% YOY). Therefore, we can’t yet say that the labor market is overheating, where labor bargaining power really takes off. 

And that isn’t such a bad thing, because often you see a process like this shortly before a recession – as in 2008 and 2011. Wage costs then rise so rapidly that companies can no longer absorb them by upping their product prices, which ultimately leads to a contraction in their profit margins and lower economic growth. 

Why, despite the tight market, is wage growth lower than you would expect? Low labor productivity in the Eurozone plays a role in this, as do changes in the current labor market caused by the increase in part-time work, the decline of union power and the fear of automation (resulting in lower wage demands). Economically speaking, there should still be some honey left in the pot for employees in the Eurozone, but changes in the structure of the labor market are limiting their potential. 

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