France Doesn't Need to Be More Like Germany

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President Sarkozy wants France to become more like Germany. 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 in terms of improved competitiveness and superior economic performance. He bemoaned the alleged decline in French industrial prowess and praised Germany's success at defending its industrial base. Is Sarkozy right to be so 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. However, the relative size of a country's industrial sector has no bearing on its economic success. Just look at Italy, which has a comparably-sized industrial sector to Germany, but which is easily the worst performing large developed economy. Japan also has a very large industrial sector but has stagnated for much of the last 20 years.

France actually has a decent economic record relative to Germany's. Between 1992 and 2001, France managed annual GDP growth of 2.1 per cent compared to Germany's 1.6 per cent. Over the subsequent ten years - 2002 to 2011 - both countries grew by (an admittedly poor) 1.1 per cent per year. Although the German economy performed better in 2010 and 2011 than its French counterpart, the two countries' growth prospects are very similar, at least according to the European Commission, the IMF and the OECD. All three forecast growth of around 0.5 per cent in 2013 and 1.5 per cent in 2013. Perhaps the best measure of economic performance is productivity. Productivity per French worker is somewhat 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 labour 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 per cent in Germany,
whereas it has risen to almost 10 per cent in France.

There is a demographic element to this - because of its very low birth-rate Germany has far fewer people entering the labour market than France. But there is clearly something else at play. The so-called Hartz reforms under the previous German government undercut the bargaining power of labour, and succeeded in pricing workers back into employment, albeit often on very low wages. Adjusted for inflation employee wages fell by 2 per cent in 2002-2011, compared with a rise of over 10 per cent in France. This, in turn, had an impact on private consumption. Over the same period, private consumption grew by just 4 per cent in Germany, against 17 per cent in France.

To the extent that Germany has become more 'competitive' this reflects wage restraint, not superior productivity growth. Wage restraint (and the resulting weakness of inflation) meant that Germany's so-called real effective exchange rate within the eurozone fell by 17 per cent between the beginning of 1999 and the third quarter of 2011, making its exports much more price competitive. Over the same period, France's real effective exchange rate rose by 4.4 per cent. 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 per cent of GDP, while Germany is running a surplus of 6 per cent. This is understandably causing anxiety in official circles in France.

France and Germany have similar levels of public debt, at just over 80 per cent of GDP. But France is running a bigger budget deficit. Whereas Germany's fell to a little over 1 per cent of GDP in 2011 (compared with 4.3 per cent in 2010), France's stood at 5.7 per cent (down from 7.1 per cent the previous year). There is no doubt that France needs to strengthen its public finances, but it is worth making a couple of points. 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 per cent of GDP compared with 1.7 per cent in Germany (the second-lowest level in the EU).

The French President is right to be worried about France's economic performance. In common with most of Europe, the country is in a rut. But it is important that the second biggest economy in Europe draws the right lessons from what has happened across the Rhine. France undoubtedly needs to reform its labour market.

At present, so-called insiders - those with full-time jobs - enjoy comprehensive rights and generous entitlements. But this acts as a disincentive for firms to hire people on full-time contracts, condemning the young to a precarious existence on temporary contracts. However, Germany's labour market reforms might not be the best blue-print for France. Germany has only been able to pursue such a strategy because others have not. If France really does attempt to emulate German wage restraint, it could prove a largely zero game, depressing domestic demand in France (and hence across Europe), in the process worsening the eurozone crisis.

There are plenty of things that other EU countries, including France, can learn from Germany. But they need to be clear about what those things are. A large industrial sector and a big trade surplus are not necessarily signs of economic prowess. And for every country running a trade surplus, there has to be one running a deficit. France has its share of weaknesses. But in some important respects the French model - where the economy is largely propelled by domestic demand - holds out better prospects for a return to economic growth across the eurozone than does the German one.

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