Transform France Into A German Economic Model? Me Thinks, Not So Fast…

German Chancellor Angela Merkel crossed traditional bounds and now campaigns vigilantly for her center-right colleague, current French President Nicolas Sarkozy, as the beleaguered French president has fallen behind in polls against his rival socialist candidate. Merkel intends to defend center-right policies and the German economic model in France, as she attempts to implement the model across all of the European Union.

Francois Hollande, socialist challenger for the French presidency, has honed his general opposition to the German-led fiscal discipline treaty under EU member states’ consideration by outlining the concrete changes he would like to see made to the document. Hollande suggests that the proposed fiscal discipline treaty imposes too much of Berlin’s belt-tightening policy (Austerity) on the EU and lacks growth initiatives.

Recently, Chancellor Merkel appeared in a joint television interview with the French president, who has fully aligned himself with German economic thinking, and said she would support him “whatever he does.” And what he does is want to transform France into the industrial economic miracle of Germany. The question is begged: why the economic self-doubt by France’s President?

President Sarkozy wants France to become more like Germany, and in a recent speech he made 15 positive references to the German economic model.

Unlike France, he argued, Germany had reformed its economy and was reaping the rewards of improved competitiveness and superior economic performance. He lamented the alleged decline in French industrial prowess and praised Germany’s success at defending its industrial base in the context of globalization.

Is Sarkozy correct in being so self-critical of French performance?  And would it make sense for France to emulate the German model?

Sarkozy is certainly right that Germany is a more industrial economy than France. The share of the French economy accounted for by industrial output is as low as in Britain (a country Sarkozy likes to deride as “having no industry”) and lower than the US. Germany’s share of world export markets has also held up remarkably well over the last ten years, whereas France’s has fallen steadily.

Nonetheless, the relative size of a country’s industrial sector may or may not have implications for its economic success. Observe Italy, with a comparably-sized industrial sector to Germany, but which is readily the worst performing large developed economy. Japan also has a very large industrial sector yet has stagnated most of the last 20 years.

France actually has a reasonable economic record relative to Germany’s.

  • Between 1992 and 2001, France managed annual GDP growth of 2.1 percent compared to Germany’s 1.6 percent. Over the subsequent ten years -– 2002 to 2011 -– both countries grew by 1.1 percent per year.
  • Although the German economy performed better in 2010 and 2011 than its French counterpart, the two countries’ growth prospects are very similar according to the European Commission, the IMF and the OECD — all three forecast growth of 0.5 percent in 2012 and 1.5 percent in 2013.
  • Productivity may be a good indicator of economic performance: Productivity per French worker is higher than in Germany, while productivity growth averaged 0.7 per year in both countries between 2002 and 2011.
  • As recently as mid-2008, rates of joblessness were the same in the two countries. But Germany’s labor market performance has been superior to France’s over the last three years. By the end of 2011 the rate of unemployment had fallen below 6 percent in Germany, whereas it has risen to nearly 10 percent in France. However, a significant demographic element led to this change –- due to a very low birthrate, Germany has far fewer people entering the labor market than France.

Something far more vital than a better, finely tuned industrial economy effected the change in balance between Germany and France.

The “Hartz reforms” of former German Chancellor Gerhard Schröder’s government undercut the bargaining power of labor, and succeeded in “pricing workers back into employment,” albeit often at much lower wages than previously known in Germany. Adjusted for inflation, employee wages fell by 2 percent from 2002 to 2011, compared with a rise of over 10 percent in France. In turn, this reduction in relative wages impacted private consumption negatively, and over the same period, private consumption grew by just 4 percent in Germany, against 17 percent growth in France.

To the extent that Germany has become more “competitive,” it is not because of  German superior productivity growth but rather because of wage restraint — and the resultant reduction of wage-based inflation. As a result of such income compression, Germany’s real effective exchange rate within the eurozone fell by 17 percent between 1999 and 2011, making its exports much more price competitive. Meanwhile, for the same period, France’s real effective exchange rate rose by 4.4 percent.

Germany’s internal devaluation contributed to a big divergence in the two countries’ relative trade positions. Whereas ten years ago France and Germany both had small current account surpluses, France is now running a deficit of around 3 percent of GDP, while Germany is running a surplus of 6 percent. To be truthful, such an effect was indeed the goal of Germany’s labor market changes… but at the expense of workers’ incomes, domestic consumption, and the social condition.

German Austerity Model For France?

France and Germany have similar levels of public debt, at just over 80 percent of GDP. Concerning the yearly budget deficit, whereas Germany’s fell from 4.3 percent in 2010 to a little over 1 percent of GDP in 2011, France’s yearly deficit came in at 5.7 percent (down from 7.1 percent in 2010). Sure, France has need to strengthen its public finances, but mitigating factors deserve acknowledgement.

First, the French government has been more concerned with maintaining growth in domestic demand than its German counterpart.

Second, over a third of the difference in the size of the deficits in 2011 was accounted for by much higher levels of public investment in France — 3.2 percent of GDP compared with 1.7 percent in Germany (the second-lowest level in the EU).

Neglecting public investment harms the overall good of the nation eventually, though… witness the crumbling infrastructure of the United States. Germany’s rail system has already fallen greatly behind that of France.

German Hartz Reforms For France & EU?

French President Sarkozy is right to be concerned about France’s economic performance. In common with most of Europe, the country seems stuck. Nonetheless, the second largest economy in Europe must draw the right conclusions from what has happened within its neighbor, Germany.

Yes, France absolutely must reform its labor market — retirement age is too young and it is too difficult to terminate non-performers. Currently, those with full-time jobs earn employee rights and generous entitlements — the hallmarks of an advanced society — even while these same benefits are a disincentive for firms to hire people on a full-time basis and relegate the youth to a tenuous reliance on temporary jobs.

However, Germany’s labor market reforms might not be the best solution for France… or Europe. Germany has been able to pursue such a strategy only as other EU countries have not. Should France attempt to emulate German wage constraint, it would prove a largely zero-sum game as the move would depress domestic demand in France and across Europe, in the process worsening the eurozone crisis and leading to more layoffs.

Certainly, Germany offers many examples for France and other EU countries to follow. Still, a large industrial sector and a big trade surplus are not the exclusive indicators of economic ability and capacity. Note that, for every country running a trade surplus, another must run a deficit, and it shall never be otherwise.

Economist Milton Friedman argued that trade deficits were not intrinsically bad. Who, he asked, has done better when one trades 10 dollars worth of goods in exchange for 15 dollars worth of goods? The one nation sold more of what it produced (which employs labor and expands business) while the other got more for less. The answer as to who has the advantage is unclear.

France has its share of weaknesses, but in important aspects, the French model — where the economy is largely propelled by domestic demand, high productivity, and extended leisure time — holds out better prospects for a return to economic growth across the eurozone than does the German economic model, I must protest.


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