by Agnès Bénassy-Quéré and Guntram B. Wolff*
France and Germany: a moment of truth
France and Germany, which together account for half of euro-area GDP, are rightly considered the key to the euro area’s exit from the current impasse of low growth, falling inflation and increasingly dangerous debt trajectories.
To break out of the current economic impasse, a bold, coordinated Franco-German strategy is needed.
To break
out of the current economic impasse, a bold, coordinated Franco-German strategy
is needed. France and Germany, which together account for
half of euro-area GDP, are rightly considered the key to the euro area’s exit
from the current impasse of low growth, falling inflation and increasingly
dangerous debt trajectories.
But more importantly, the German-French couple is
a clear example of the need for a coordinated strategy. Their unit labour costs
have diverged by some 20% since the introduction of the single currency.
This
would not necessarily be worrying, but the world market share of French exports
has fallen by more than twice that of Germany, and the current account gap has
increased by more than 8% of GDP.
France has not compensated for its rising
costs by higher non-price competitiveness, while the German low-cost strategy
has made the country more and more dependent on foreign markets.
The steady
decline in inflation and the increase in the euro area’s current-account
surplus are an indication that aggregate demand is too low in the euro area and
in France and Germany.
The stagnation of total factor productivity since the
mid-2000s in several euro-area countries (including France) is an indication
that deep reforms are needed for long-term growth to restart, and therefore for
the sustainability of social systems.
To break
out of the current economic impasse, a bold, coordinated Franco-German strategy
is needed. It requires simultaneous implementation of measures in both
countries.
Currently,
there is no political consensus in France for far-reaching reforms that would
encompass structural spending cuts and changes to some services market
regulations, and would also improving the functioning of the labour market.
This could be done, for example, by reconsidering the labour contract in order
to incentivise long-term hiring, or averaging working time across the year,
rather than week by week, which would be a smooth way of reducing unit labour
costs.
There is also, so far, no consensus in France on the need for education
system reform. Such reforms would boost French productivity growth, stimulate
innovation and also help to narrow the unit labour cost gap with Germany.
Before the
full gain from productivity can be reaped, wages and other costs such as
housing will need to grow more slowly in France than in Germany, so that the
former can regain competitiveness and the latter can alleviate its excess
dependence on external demand.
Germany
should gear its efforts to boosting its own economic activity. Boosting
domestic demand is part of the answer and could be quickly achieved through
lower taxes on low-income households and a credible strategy for public
investment.
For this, accepting that the “black-zero” balanced budget must be
given up is essential. But structural reform to develop the non-traded goods
sectors, for example IT services, is also essential.
The introduction of a
minimum wage next year increases the need to focus on such high value-added
sectors. The education system should support a shift to the new growth sectors
of the 21st century, where Germany is lagging behind.
This renewed economic
dynamism needs eventually to lead to an inflation rate of above 2 percent,
which is required to support the rebalancing.
With the
prospect of an increase in demand and inflation in Germany, the French
government would have more leeway to cut social contributions and social
spending, and to implement far-reaching structural reforms.
The French
government’s recent announcements of reforms to protected sectors, although
going in the right direction, will not be sufficient. Aggregate demand is not
only a question of fiscal stance.
France needs to reduce the uncertainty
surrounding future policies, which is currently a powerful drag on private
investment. Clarifying the future path of tax rates and energy and carbon
prices is one issue.
Agreeing on a number of medium-term fundamental objectives
covering issues such as vocational training, tertiary education, lifetime
working hours, the health system and housing subsidies, are needed to anchor
expectations.
Credibility, through political agreement on medium-term
objectives is needed to trigger private investments.
The success
of such a joint strategy will of course depend on what happens at euro-area
level: on the ability to finance European Commission president Jean-Claude
Juncker's €300 billion investment project with fresh money, on the willingness
of the European Central Bank to do what it considers necessary to meet its
target of an inflation rate “below but close to 2 percent”, and on the ability
of the European Commission and the European Council to enforce the fiscal rules
without suffocating the economy.
France and Germany have a major responsibility
as shareholders in the European Investment Bank and as direct participants in
the European Council.
But, equally importantly, they have a responsibility to
reduce the structural divergence between them by introducing coordinated deep
economic reforms at national level.
*Agnès Bénassy-Quéré is the Director of the
CEPII, the leading French research institute in international economics, and a
Professor at University Paris X – Nanterre (on leave). Guntram Wolff is the
Director of Bruegel since June 2013. His research focuses on the European
economy and governance, on fiscal and monetary policy and global finance.
MORE ON Europe needs Rethinking
- Jean-Claude Juncker: the man of 300 (?) billion
- The Eerie Silence Before the EU Reform Storm
- What’s needed is a much more visionary EU industrial policy
- Four principles for an effective state