With energy prices high and rising, and inflation soaring, it is starting to look like the late 1970s all over again. But appearances can be deceiving.
The similarities are obvious. In 2022, like in the 1970s, an energy-price shock has led to a sustained increase in the prices of many other goods. The so-called core inflation rate, which strips out volatile energy and food prices, is now approaching 6% in the United States and 4% in the eurozone. And fears are mounting that, as in the 1970s, this trend will prove persistent.
But we are hardly living through a repeat of the 1970s. One key difference lies in labor markets. Back then, widespread wage indexation meant that higher energy and other prices led automatically to an equivalent increase in wages. Where wage indexation was less important, unions achieved the same outcome, as they refused to accept any deterioration in their members’ living standards.
This is not the case today, at least in the eurozone. According to the European Central Bank’s new wage tracker, eurozone wages have increased by only 3% so far – far less than the 8.6% inflation recorded in June. In other words, there is no sign of the wage-price spiral of the 1970s.
Another difference today is that European producers have been able to increase their prices enough to offset a significant portion of the energy-cost rise. Based on June 2022 prices, the eurozone’s energy import bill is set to increase by over 4% of GDP this year. Over the last year, surging energy prices have fueled a 24% increase in the European Union’s import prices, after more than a decade of stability.
But the prices charged by EU exporters also rose, by over 12% – and the EU exports more than it imports. European producers have thus been able to offset slightly more than half of the income loss from higher energy prices, keeping it to just under 2% of GDP. This is a hefty price to pay, but it is also a manageable one.
The challenge will be to distribute income losses across economic sectors. With real wages having fallen by about 5%, European workers have so far borne all the costs of inflation. Given that the wage share amounts to about 62% of GDP in the eurozone, a 5% fall in real wages would make available to other sectors about 3.1% of GDP, more than the income loss of 2%, allowing profits to increase. That is more than sufficient to offset the terms-of-trade losses suffered so far.
The situation is very different in the US. As the world’s biggest oil and natural-gas producer, it exports as much energy as it imports. America’s terms of trade thus have not suffered at all, with import and export prices increasing by the same amount. But wages have increased by over 6%, according to the Federal Reserve Bank of Atlanta’s wage tracker, meaning that the US is much closer to a wage-price spiral than Europe.
How reliable is Europe’s wage moderation? As it stands, the EU is experiencing more inflation in profits than in wages, despite the overall income loss. And falling real wages are particularly difficult to accept when profits are soaring. In fact, wage demands are already creeping up across the eurozone. Germany’s influential IG Metall union, for example, is calling for an 8% wage hike for workers in the metal industry, which currently is enjoying high profits. To keep social peace, several countries, including Germany, have introduced double-digit increases in minimum wages.
Nonetheless, negotiated wage increases have so far remained modest, at around 4%, according to the ECB. Actual wages might climb further, as employers in sectors experiencing shortages decide that it is worth paying workers a premium. Still, there is little indication that wages are set to catch up with inflation any time soon.
The main reason for this is that governments all over Europe are delivering direct transfers to households, in order to offset higher energy costs. For example, Germany’s government has unveiled a relief package that includes a lump-sum payment for employees and a heating-cost subsidy for households on housing benefits.
The Spanish government, for its part, is subsidizing the cost of natural gas for power producers. This approach to holding down electricity prices is flawed, as it encourages gas use at a time when Russian President Vladimir Putin is threatening to cut supplies. But such schemes reflect a new social contract that is emerging in Europe: governments protect workers from the bulk of higher energy costs, in exchange for workers moderating their wage demands.
In the aftermath of the 2008 global financial crisis, a recurrent criticism of the eurozone framework was that the absence of a fiscal authority meant that the ECB was “the only game in town.” This time seems different. By stepping in to provide income support, governments are helping to prevent a 1970s-style wage-price spiral – and making the ECB’s job much easier.
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