Opinion

France and Germany must both change economic strategy

A more balanced economic strategy in the two countries is crucial to help the peripheral countries solve their own predicaments and ensure the sustainability of the euro area.

By: Date: February 13, 2014 Topic: European Macroeconomics & Governance

This op-ed was published in French by Le Monde and in German by Handelsblatt.

The euro was first and foremost a Franco-German project, not only politically but also economically. Thanks to its stability culture, Germany had a strong currency. At times, when the dollar was weak, the D-mark was even too strong, penalizing German exporters in favor of their European competitors. Germany was therefore keen to have France and other EU countries peg their currencies to the D-mark. For its part, France was keen to also have a strong currency (a ‘franc fort’), but it lacked the necessary stability culture. The way to import it was to peg the franc to the D-mark, but politically it was difficult for France to surrender its monetary sovereignty to the Bundesbank. Monetary union was the way to give both countries what they wanted by transferring monetary sovereignty to a European central bank and give it a price stability mandate. And so the euro was born.

Unfortunately right before the creation of the euro, Germany suffered an unexpected shock. Reunification led to massive public expenditures and deficits, to which the Bundesbank reacted by tightening monetary policy to maintain price stability. Thus, when Germany joined the euro its currency was strongly overvalued. The early years of the euro were painful for the ‘sick man of Europe’: unemployment, which had traditionally been low (and always lower than in France), rose steadily, reaching a post-war high of more than 11 per cent (2 points higher than in France) in 2005; public deficits remained persistently above the 3 per cent limit between 2001 and 2005; and public debt reached a record of 68 per cent in 2005.

How did Germany turn the situation around? The short answer is structural adjustment and help from the peripheral euro area countries. The Hartz reforms significantly reduced labor costs and restored German competitiveness. At the same time expansion in the peripheral countries, fuelled partly by German capital flows in search of investment opportunities, helped absorb German output when domestic conditions were subdued. As a result, the German current account balance, which had been negative every year since reunification, turned positive in 2002 and reached more than 5 per cent in 2005, a level where it remained thereafter. Export-led growth transformed Germany into the ‘healthy woman of Europe’, which today enjoys near full employment and balanced budgets. Yet not all is well. The current situation of internal balance but external surplus suggests that Germany’s competitiveness adjustment has gone too far and is especially detrimental to the peripheral euro countries whose turn it is now to restore their competitiveness. Unfortunately adjustment is difficult in a situation where demand is depressed not only at home but also in the rest of the euro area.

Germany alone however cannot rescue the peripheral countries. France, the area’s second largest member, must also do its part. But the country is itself in difficult situation. At the start of the euro, France and Germany had identical unemployment rates, per capita incomes (in purchasing value) and debt-to-GDP ratios. Today the unemployment rate in France is two times higher than in Germany, its per capita income is 15 per cent lower but its debt-to-GDP is 15 per cent higher. Such divergence between the two countries is bad for France and for its capacity to work with Germany to repair the euro project.

Why have France and Germany diverged so much? The simple answer is that they have adopted different economic strategies. Germany has become an extremely open economy, with exports (goods and services) now accounting for more than 50 per cent of GDP, a figure even higher than in small open economies like Sweden or Switzerland. Its economic policy is dominated by its large manufacturing where employers and workers collaborate closely to foster export competitiveness. One way to ensure that the manufacturing sector remains competitive is to squeeze costs in the non-traded sector, where wages have been kept relatively low. By contrast, France has remained a relatively closed economy, with exports now accounting for barely 27 per cent of GDP, a figure even lower than in Italy. Here economic policy is dominated by the interests of public workers and large private firms closely linked to the state, which implies large public expenditure. One way such expenditures (currently equal to 57 per cent of GDP in France compared to only 45 in Germany) largely in favor of the non-traded sector is to tax the traded sector. No wonder the country is losing export competitiveness.

France and Germany must both change their economic strategy. Germany must reduce its over-reliance on exports and expand both its non-traded (service) activities and its internal demand. France must reduce its over-reliance on publically-financed internal demand and tax less its economy, especially in the traded sector. A more balanced economic strategy in the two countries is crucial to help the peripheral countries solve their own predicaments and ensure the sustainability of the euro area.


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint.

Due to copyright agreements we ask that you kindly email request to republish opinions that have appeared in print to communication@bruegel.org.

View comments
Read article More on this topic

Blog Post

A European anti–money laundering supervisor: From vision to legislation

In fighting anti-money laundering, the European Commission should act fast toward creating a central supervisory authority.

By: Nicolas Véron and Joshua Kirschenbaum Topic: European Macroeconomics & Governance Date: January 24, 2020
Read article More on this topic More by this author

Blog Post

How could net balances change in the next EU budget?

The gap between payments into the EU budget and EU spending in a particular country has importance when EU spending does not constitute European public goods, or there are risks for their improper use. I estimate that the Juncker Commission’s proposal for the next seven-year budget would lead to big reductions (as a share of GNI) in the net payments to most central European countries, while the changes for other countries seem small

By: Zsolt Darvas Topic: European Macroeconomics & Governance Date: January 23, 2020
Read about event

Upcoming Event

Jan
28
09:30

A post-Brexit agreement for research and innovation

What is the future of EU's and UK's relationship on research and innovation?

Speakers: Gina Dowding, Michael Leigh, Adrian Hayday, Clare Moody, Martin Muller, Joe Owen, Jaroslaw Pietras, Uta Staiger, André Sapir, Beth Thompson and Guntram B. Wolff Topic: European Macroeconomics & Governance, Innovation & Competition Policy Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read article

Blog Post

Incorporating political risks into debt sustainability analysis

DSA applies to crisis countries only, but an early warning system identifying vulnerabilities is relevant for all countries. A more general, less stringent, debt vulnerabilities analysis (DVA) could be used to assess countries’ debt management policies and identify vulnerabilities, without leading immediately to policy consequences. A more general framework could also incorporate political risks that are significant determinants of debt dynamics

By: Stavros Zenios and Andrea Consiglio Topic: European Macroeconomics & Governance, Global Economics & Governance Date: January 22, 2020
Read about event

Past Event

Past Event

The state of health in the EU and the digitalisation of health promotion

The panellists at this event reviewed the general state of health as well as the digitalisation in the industry.

Speakers: Stefania Boccia, Caroline Costongs, Katarzyna Czabanowska, Zsolt Darvas, Guillaume Dedet, Martin Dorazil, Josep Figueras, Joanna Kokot, Martin Seychell and Michael Strübin Topic: European Macroeconomics & Governance, Innovation & Competition Policy Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: January 22, 2020
Read article Download PDF More on this topic

Policy Contribution

Market versus policy Europeanisation: has an imbalance grown over time?

This Policy Contribution tests the hypothesis that an imbalance has grown in Europe over the last few decades because markets have integrated to a greater extent than European-level policymaking, potentially creating difficulties for the democratic process in managing the economy. This hypothesis has been put forward by several authors but not so far tested empirically.

By: Francesco Papadia and Leonardo Cadamuro Topic: European Macroeconomics & Governance Date: January 9, 2020
Read article More on this topic More by this author

Opinion

Understanding populism

Political identity is a group stereotype. As no camp corresponds exactly to our expectations, we choose the one to which we are closest and which is also the most distant from the ideas we reject

By: Jean Pisani-Ferry Topic: European Macroeconomics & Governance Date: January 2, 2020
Read article More by this author

Blog Post

2019 on #econtwitter, in a million tweets

What did academic economists talk about in 2019? I collected one million tweets from popular academic economists over the year, and analysed the topics discussed.

By: Enrico Bergamini Topic: Energy & Climate, European Macroeconomics & Governance, Finance & Financial Regulation, Global Economics & Governance, Innovation & Competition Policy Date: December 19, 2019
Read article More on this topic More by this author

Podcast

Podcast

The Sound of Margrethe Vestager

Will AI exacerbate the gap between big companies and small ones? Do ordinary Europeans gain anything from having European tech giants? This week, Nicholas Barrett and Guntram Wolff went to the Berlaymont to interview Margrethe Vestager, the Executive Vice President of the European Commission for a Europe Fit for the Digital Age.

By: The Sound of Economics Topic: European Macroeconomics & Governance Date: December 19, 2019
Read article Download PDF More on this topic More by this author

Policy Contribution

Can EU competition law address market distortions caused by state-controlled enterprises?

The distortive effects that foreign state-owned or state-supported companies can have on European markets and on the European Union’s economic autonomy are starting to worry policymakers

By: Mathew Heim Topic: European Macroeconomics & Governance Date: December 18, 2019
Read article More on this topic More by this author

Blog Post

How much will the UK contribute to the next seven-year EU budget?

This post estimates the United Kingdom’s net contribution to the 2021-2027 EU multiannual budget at close to €20 billion, taking into account the most significant items of the financial settlement according to the October 2019 EU27-UK draft withdrawal agreement.

By: Zsolt Darvas Topic: European Macroeconomics & Governance Date: December 16, 2019
Read article Download PDF More on this topic More by this author

Working Paper

A new look at net balances in the European Union's next multiannual budget

Whenever the European Union’s budget is discussed, much of the political focus is on net balances – whether countries pay in more than they receive – rather than on the broader overall positive effects of EU spending. The largest net contributor countries have sought to limit their contributions, leading to the build-up of an ad-hoc, complex, opaque and regressive system of revenue corrections.

By: Zsolt Darvas Topic: European Macroeconomics & Governance Date: December 12, 2019
Load more posts