Spend and reform Better Together

Two leading economists from France and Germany argue that the two countries must team up – Germany by spending, France by reforming – if Europe is to overcome its economic woes.
Europe needs some major repair work.

It's safe to say that France and Germany are key to getting Europe's economy back on its feet. Together they account for half of the gross domestic product of the entire euro zone – reason enough to work together.

Since the euro was introduced in 1999, labor costs have risen faster in France and are now 20 percent higher than in Germany. That alone should not be cause for concern.

But French exports have fallen more than twice as much as Germany’s, and a trade balance gap of more than eight percent of GDP has emerged.

France has not compensated for its rising costs with increased competitiveness. And with its low-cost strategy, Germany is becoming more and more dependent on foreign markets.

Since the euro was introduced in 1999, labor costs have risen faster in France and are now 20 percent higher than in Germany.

Now a bold, coordinated strategy between France and Germany is needed to break Europe’s economic stagnation. This must include the simultaneous implementation of policies in both countries.

However, there is no political consensus in favor of extensive reforms in France, whether for reduced spending or an improved labor market. The model for French labor contracts, for instance, offers little inducement for hiring workers over the long term. An average annual total of working hours, instead of the currently used weekly total, would be a simple way to reduce unit working costs.

But before increased productivity can be felt, growth in wages and other costs – for example rents – must become slower in France than in Germany. That way France can restore its competitiveness and its neighbour can reduce its overdependence on foreign demand.

Germany needs to stimulate its economy. Strengthening domestic demand is part of the solution and could quickly be attained by reducing taxes for households with low income, as well as with a credible concept for public investments. Germany must abandon its balancing-budget mantra on public spending. 

Germany needs to stimulate its economy.

This new economic dynamism could ultimately lead to an inflation rate above 2 percent, which is necessary for re-establishing economic equilibrium in the 18-nation euro zone.

If it could bank on increasing demand and inflation in Germany, the French government would in turn have more wiggle room to reduce social spending and begin sweeping structural reforms. The most recent initiative of the French government to reform protected sectors, such as the railways, is a step in the right direction, but it is not enough.

Overall economic demand is not simply a matter of financial policies. France also needs to reduce uncertainty about its political direction, which currently impedes investment. There needs to be more clarity on tax rates, as well as energy and carbon prices. Agreement must also be reached on mid-range reforms in vocational training and college education, lifetime working hours, the health-care system and housing benefits.

The success of such a coordinated strategy would of course depend greatly on what happens in the euro zone.

Will it be possible to finance the €300 billion E.U. investment project proposed by the European Commission president, Jean-Claude Juncker, this week? Can the European Central Bank do what it considers necessary to push Europe’s inflation rate to near 2 percent? And can the European Commission, the E.U.'s executive arm, and Council, made up of heads of state, adopt tough budget regulations without strangling the economy?

France and Germany carry a great responsibility as shareholders in the European Investment Bank and as members of the European Council. It is also important that they work on reducing the structural differences that exist between them – through coordinated and far-reaching reforms on a national level.

 

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