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.