July 10, 2006
Disaster averted: The German health reform and EMU
Not much noticed outside of Germany, a reform proposal was put to death last week which would have seriously engraved economic divergences in the euro-zone. In the discussion of how to reform the health care system, the social democrats had floated the idea to increase VAT and personal income taxes to finance the public health care system by up to 45 bn. € and to lower social security contributions paid by employers and employees by the same amount.
Such a reform would have lowered unit labour costs paid by the employers by more than 2 percent (45 bn. € amounts to roughly 4 percent of the wage sum. Given that both employers and employees pay for the social security contributions, half of the reduction would have gone to employers).
After years of real depreciation by wage restraint (German unit labour costs only increased by 0.5 percent in nominal terms between 2000 and 2006, while the euro-area’s unit labour costs increased by some 10 percent and Italian, Spanish or Portuguese unit labour costs increased by roughly 20 percent over that time period), this would have meant a further increase in German competitiveness, especially as German wages continue to grow much slower than those in the rest of the euro-area.
Good news for Italy and Portugal
Especially for countries such as Portugal or Italy, this would have made any adjustment of their competitive position back towards equilibrium even harder, increasing the likelihood of a break-up of EMU in the future.
Remember: Even though the Portuguese economy has only been growing by meagre 0.4 percent annually since 2001, it has not been able to regain competitiveness. Portugal’s current account deficit now runs at almost 10 percent of GDP with no improvement in sight, while the German current account surplus is close to 100 bn €, or more than 4 percent of its GDP.
So, even if German commentators lament the failure of the government to reform the financing side of the health care system, this might be positive news: The neighbours in EMU were spared yet another beggar-thy-neighbour-like real depreciation of the euro-area’s biggest economy.
[For those who read German, a more detailed analysis on the German reform of the health care system and divergences in the euro-area is found in today’s Financial Times Deutschland].