Underemployment to keep a lid on German pay growth

The recent drop in German unemployment points to a sharp rise in wages that might make ultra-loose ECB policy difficult to justify. But there is more slack in the labour market than the headline figures imply and analysts suspect that pay growth will remain subdued. 

While unemployment elsewhere in the euro-zone has remained stubbornly high, the German rate has fallen steadily from its 2005 peak of 11.3% to just 4.7% in March this year. This is below estimates of the "non-accelerating inflation rate of unemployment" (or NAIRU), which are typically close to 6%. A deviation would ordinarily prompt a sharp rise in wage growth and yet hourly labour costs rose by just 1.6% in the year to Q1. 

What's more, the fall in measured unemployment has not reflected disillusioned workers giving up their search for work. Indeed, German labour force participation has risen as a share of the working-age population over recent years. At 60%, it is well above the French equivalent of 53% and Italy's 48%. 
But there are good reasons not to take the German unemployment figures at face value. The Hartz labour reforms of 2003-2005 encouraged more people into employment by lowering the employee tax rate for jobs with low wages and short hours (so-called "mini-jobs" and "midi-jobs"). 

While this has reduced the unemployment rate, the hours worked have fallen steadily and they are also far lower than the euro-zone average. Part-time jobs now account for 27% of total German employment compared to about 19% in France and Italy and 16% in Spain, notes Capital Economics. This has increased the proportion of German workers on very low incomes and raised concerns about inequality. 

Meanwhile, "ein euro" jobs have been introduced in the public sector to allow previously unemployed people to go on claiming benefits while also being employed by the state on very low pay. Although these people are registered as employed, they are putting no pressure on aggregate wage growth. 

All of this points to a degree of so-called "underemployment" (where workers have jobs but would like to work more), which could explain the subdued rate of labour costs growth. It might also explain the disconnect between the hard data and German peoples' perceptions of labour market conditions - until this March, respondents to the GfK consumer survey persistently saw unemployment rising.