It is widely observed that there are major dislocations in European labor markets. Debate over reforms of present labor regulations in Germany, for instance, has basically paralyzed the government as last Sunday's elections gave no party or policy anything close to a majority vote.

Thus, it is interesting that data reported today by Eurostat show that hourly labor costs in Europe have been rising rather modestly, and they compare favorably with similar information for the US. In the overall Euro-Zone, this gauge rose a mere 0.5% in Q2 (2.1% annualized) and was just 2.3% above a year ago. In Germany, where there is much distress in the labor market, the hourly labor cost index edged up just 0.1% in the quarter, and as seen in the table below, just 0.8% from a year ago. Somehow, public discussion of these labor developments gives the impression that the associated costs are quite high. But these costs increasing very slowly, and in the second graph, it is seen that they are retreating rapidly as a share of national income.

In the face of high unemployment in Germany, what we seem to have is an excellent example of a Phillips Curve phenomenon: high unemployment combined with low inflation of labor costs. Generally this is seen as a demand-driven condition, but here it is likely exacerbated by the rigidities in the applicable regulations.

In Europe as a whole, demand appears to be a leading force on labor costs. The correlation of GDP growth (in nominal terms) with labor cost increases is 48% in the same quarter, but with a two-quarter lead for GDP, the correlation jumps to 76%. In the last two quarters the pace of GDP has slowed further, suggesting that it is difficult to look for much improvement in labor compensation over the remainder of this year.