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: Macroeconomic policy

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 [email protected].

Read about event More on this topic
 

Upcoming Event

Nov
4
14:00

European monetary policy: lessons from the past two decades

This event will feature the presentation of “Monetary Policy in Times of Crisis – A Tale of Two Decades of the European Central Bank."

Speakers: Petra Geraats, Wolfgang Lemke and Francesco Papadia Topic: Macroeconomic policy
Read article More by this author
 

Opinion

European governance

Can EU fiscal rules jump on the green bandwagon?

By and large, setting a new green golden rule would be a useful addition to the existing EU fiscal framework.

By: Guntram B. Wolff Topic: European governance, Green economy, Macroeconomic policy Date: October 22, 2021
Read about event More on this topic
 

Upcoming Event

Nov
9
11:00

Phasing out COVID-19 emergency support programmes: effects on productivity and financial stability

How can European countries phase out the COVID-19 support measures without having a negative impact on productivity and financial stability?

Speakers: Maria Demertzis and Laurie Mayers Topic: Macroeconomic policy
Read article
 

Blog Post

European governance

Germany’s post-pandemic current account surplus

The pandemic has increased the net lending position of the German corporate sector. By incentivising private investment, policymakers could trigger a virtuous cycle of increasing wages, decreasing corporate net lending, which would eventually lead to a reduction of the economy-wide current account surplus.

By: Lionel Guetta-Jeanrenaud and Guntram B. Wolff Topic: European governance, Macroeconomic policy Date: October 21, 2021
Read about event
 

Past Event

Past Event

Monetary policy in the time of climate change

How does climate change influence monetary policy in the eurozone? What potential monetary policy measures should be taken up to address climate risks?

Speakers: Cornelia Holthausen, Jean Pisani-Ferry and Guntram B. Wolff Topic: Green economy, Macroeconomic policy Date: October 20, 2021
Read article More by this author
 

Podcast

Podcast

Rethinking fiscal policy

A look at the past, present and future of fiscal policy in the European Union with Chief economist of the European Stability Mechanism, Rolf Strauch.

By: The Sound of Economics Topic: European governance, Macroeconomic policy Date: October 20, 2021
Read article
 

External Publication

European Parliament

Tailoring prudential policy to bank size: the application of proportionality in the US and euro area

In-depth analysis prepared for the European Parliament's Committee on Economic and Monetary Affairs (ECON).

By: Alexander Lehmann and Nicolas Véron Topic: Banking and capital markets, European Parliament, Macroeconomic policy Date: October 14, 2021
Read article More by this author
 

External Publication

Global Economic Resilience: Building Forward Better

A roadmap for systemic economic reform calling for step-change in global economic governance to increase resilience and build forward better from economic shocks, prepared for the G7 Advisory Panel on Economic Resilience.

By: Thomas Wieser Topic: Global economy and trade, Macroeconomic policy Date: October 14, 2021
Read article More on this topic More by this author
 

Opinion

Letter: Declining investment may explain why rates are low

Perhaps an analysis of the causes of the declining investment rate would bring us closer to explaining why real interest rates are so low.

By: Marek Dabrowski Topic: Macroeconomic policy Date: October 1, 2021
Read article More by this author
 

Podcast

Podcast

A green fiscal pact

How can the European Union increase green public investment while consolidating budget deficits?

By: The Sound of Economics Topic: European governance, Macroeconomic policy Date: September 29, 2021
Read article More on this topic More by this author
 

Blog Post

Monetary arithmetic and inflation risk

Between 2007 and 2020, the balance sheets of the European Central Bank, the Bank of Japan, and the Fed have all increased about sevenfold. But inflation stayed low throughout the 2010s. This was possible due to decreasing money velocity and the money multiplier. However, a continuation of asset purchasing programs by central banks involves the risk of higher inflation and fiscal dominance.

By: Marek Dabrowski Topic: Macroeconomic policy Date: September 28, 2021
Read article More on this topic More by this author
 

Opinion

The pandemic’s uncertain impact on productivity

The pandemic has certainly permanently affected our way of working. Whether this is for the better remains to be seen.

By: Maria Demertzis Topic: Macroeconomic policy Date: September 28, 2021
Load more posts