Learning to live in Euroland The role of France and Germany Conference

1. Learning to live in Euroland The role of France and Germany Conference France and Germany in the International Division of Labour  Centre Saint-Gobain for Economic Studies Paris, 9-10 December 2004 Stefan CollignonProfessor of European Political Economy LSE

2. Learning to live in Euroland Professor Stefan Collignon • Franceallemagne as motor of European integration? • “Red lanterns” in Euroland ? • Rigid labour markets ? • An out-dated social model ? • A more complex reality • Fundamental change is the monetary system • from Bretton Woods to EMS to EMU • Adjustment to the new reality takes more than labour market reforms

3. Learning to live in Euroland Professor Stefan Collignon • Economic convergence as a precondition for political union • A remarkable degree of convergence has taken place • Germany suffers from German unification • Fiscal policy suffers from institutional deficiencies and this blocs economic growth and employment in Euroland • Unless political initiative emerges from France and Germany, 50 years of integration will perish • Economic stagnation is systemic • Collective action problem in EU25 • bad policy output undermines legitimacy But France and Germany have ideologically converged

4. Learning to live in Euroland Professor Stefan Collignon •  1. The problem with economic growth • GDP trendgrowth has been higher in France than Germany, although only by a small amount (less than 1 %) • Historic turning points: • - End of Bretton Woods and 1. Oil shock • - 2. Oil shock and EMS • - German unification and Maastricht • - Euro • growth rates have been highly correlated since the mid 1980s (Correlation coefficient 0.60-0.90) • - only national shocks: early Mitterrand years and German unification

5. Learning to live in Euroland Professor Stefan Collignon • Per capita income (in euros) has also converged in France and Germany • but growth is less in UK and USA (strong exchange rates!)

6. Learning to live in Euroland Professor Stefan Collignon • Two reasons for slow income growth • Productivity has persistently slowed down • Deterioration faster in Germany since unification • Deterioration accelerated in France due to 35 heures • Capital intensity has slowed in F-D, increased in UK-US

7. Learning to live in Euroland Professor Stefan Collignon • Two reasons for lower income growth • Employment rate is improving in France, but not in Germany • Dramatic deterioration in East German manufacturing • New jobs in services (F 2.7, D 4.3, UK 2.9 over 1992 to 2001)

8. Learning to live in Euroland Professor Stefan Collignon Job creation is low when GDP growth is below productivity growth Germany France

9. Learning to live in Euroland Professor Stefan Collignon • Total Factor productivity (the efficiency of combining labour and capital) is also disappointing • Surprising cyclicality • Possibly related to low investment • - lower incorporation of new technologies

10. Learning to live in Euroland Professor Stefan Collignon Investment ratio has collapsed: Why?

11. Learning to live in Euroland Professor Stefan Collignon • Insufficient demand • Output gaps are negative • - in size (controversial) • - in frequency

12. Learning to live in Euroland Professor Stefan Collignon The likelihood of insufficient demand is not 50:50 Germany After 1980: 66 % France After 1980: 60 %

13. Learning to live in Euroland Professor Stefan Collignon • Insufficient demand affects the expected profitability of firm’s new investment • labour markets cannot be blamed for low profits

14. Learning to live in Euroland Professor Stefan Collignon • Nominal wage moderation is higher then in the 1960s • In Germany wages are stagnating • In France they increase less then in the UK

15. Learning to live in Euroland Professor Stefan Collignon • But entrepreneurial profits are improving • cost of capital have fallen with lower interest rates, while unit labour costs have stabilised • Tobin’s q has improved (Ratio of market prices to cost of production) • - More of the rising capital income share gores to real investment, less to rentiers

16. Learning to live in Euroland Professor Stefan Collignon • The public sector • Expenditure in France and Germany larger than in UK or US • But no change over recent years • - no evidence for lower growth • in Scandinavia it is even higher • no stifling of lower growth • Public investment • is stable at 3 % of GDP in France • has fallen to historic low of 1.7 % in Germany

17. Learning to live in Euroland Professor Stefan Collignon • The public sector • But the financing of public expenditure is reflecting the “conservative” model of welfare state • in France high social contribution until Juppé- reforms 1996 • in Germany social contributions are Kohl’s Portokasse Total tax burden Taxes Social contributions

18. Learning to live in Euroland Professor Stefan Collignon • To summarise: • Economic structures in France and Germany have converged • - they are more alike than anglo-saxon economies • The handicap is macroeconomic policy • - in EMU this is a matter of the policy mix • monetary policy interacts with fiscal and wage policies • Can Francallemagne improve their situation by “economic reforms”?

19. Learning to live in Euroland Professor Stefan Collignon • Is the labour market too rigid? • Mobility: high in Germany  led to same wage levels in East and West • Are wages too high? • Unskilled workers: reforms have happened • Average wages reflect productivity: unit labour costs

20. Learning to live in Euroland Professor Stefan Collignon • No competitive disadvantage for Franceallemagne • Both countries’ ULC are below Euroland average • stable in France • decreasing in Germany  build up of advantage France Germany

21. Learning to live in Euroland Professor Stefan Collignon • This adjustment is justified, because Germany has lost the DM-advantage of low interest rates • it translates into renewed competitiveness • exports are increasing: from 25.7 % of GDP in 1999 to 32 % in 2004 • But France gained from losing FFr, hence more stable ULC • But does not solve the problem, when lower ULC simply lead to falling prices rather than higher profits • - problem of large countries

22. Learning to live in Euroland Professor Stefan Collignon • But profits do not improve enough • Higher RoC elsewhere • - France and Germany have converged • but higher RoC in IRL, Sweden, US, UK

23. Learning to live in Euroland Professor Stefan Collignon • Average productivityof capital stock is higher in anglosaxon and Scandinavian countries • job protection versus income protection? • low investment rate slows modernisation of capital stock • Investment reponds to Tobin’s q • q responds to monetary policy • In Franceallemagne still below Euroland average • although ULC are falling, prices are also falling relative to Euroland price level: why?

24. Learning to live in Euroland Professor Stefan Collignon • The policy mix • Overriding priority of price stability • ECB must respond to ULC-developments (supply side) • ECB must respond to fiscal policy (demand side) • - Aggregate fiscal stance for Euroland • National responsibility • Coordination only by SGP

25. Learning to live in Euroland Professor Stefan Collignon ECB takes both factors into account But fiscal deterioration prevents lower interest rates

26. Learning to live in Euroland Professor Stefan Collignon • ECB is more concerned about fiscal than wage policy • SGP is not implemented • Commission has no ultimate power • Therefore: there exists no European fiscal policy and policy mix is sub-optimal

27. Learning to live in Euroland Professor Stefan Collignon • The solution • Define aggregate fiscal stance for Euroland at EU-level • Allocate deficit permits to member states for implementation • But: binding obligation is only possible with full democratic backing • - vote by European parliament • - create European political Union with full democracy

28. Learning to live in Euroland Professor Stefan Collignon • This is where France and Germany have a role to play • But ultimately it is up to European citizens to charge the institutions with the proper management of their common affairs • European democracy is the next step!

29. Learning to live in Euroland Professor Stefan Collignon • Ceterum censeo: • pactum stabilitatis esse delendum • Et rem publicam europaeam esse errigendam