The ECB’s outright monetary transactions are a game-changer. OMT’s soothing power stems from the fact that market participants in effect see them as a commitment to the mutualisation of liabilities across the eurozone: countries standing together behind the debts of the vulnerable. But in reality, the eurozone is far from such a stable position.
Lasting and credible burden-sharing – for example, through eurozone bonds – cannot be imposed by unelected central bankers. It will require political leadership and broad support from electorates. Crucially, it will need to be accompanied by further ceding of national sovereignty by the 17 members of the eurozone to limit any future buildup of national indebtedness. It will not be an easy process, as amply demonstrated by the slow and painful progress towards a banking union.
It has become conventional wisdom that little can happen before the German general election in September. But sooner or later, Europe will need to determine whether to make this fundamental change to the design of political and monetary union.
And one thing is already clear: Germany will not and should not go down this route if it is the only large healthy economy in the eurozone. That means Germany will need to be assured of two things. First, that France – the second largest eurozone economy – will also be among the strong. Second, that the French and German economies will be sufficiently aligned for the two countries to have broadly common interests as they jointly shape the terms and conditions of mutualisation and deeper political union in Europe.
History suggests that it is reasonable for Germany to expect such assurances. Data since 1980 — and indeed since re-unification — shows that the German and French economies have grown at the same rate, on average. Admittedly France ran slightly larger budget deficits than Germany. But until the financial crisis, that difference was small – less than half of one percentage point of their respective gross domestic products. The Germans rightly expect their French partners to stand shoulder-to-shoulder and be well aligned. What terrible timing it is, therefore, that these economies have diverged by more than at any time over the past 30 years.
Virtually every economic indicator tells the same unhappy story. France’s fiscal deficit stood at around 4.5 per cent of GDP in 2012, while Germany’s government balanced its budget. Despite weak domestic demand, France’s current account remains stubbornly in deficit, versus Germany’s huge surplus. And French unemployment is now around 5 percentage points higher than in Germany – the biggest difference for more than three decades (see chart below). Most shockingly, youth unemployment now stands at 26 per cent in France versus 8 per cent in Germany.
This dramatic divergence surely reflects a lack of reform in France over at least the last decade. During the same time, Germany realigned its economy to boost potential growth and reduce unemployment. As a result, France’s government currently spends around 56 per cent of GDP – more than 10 percentage points higher than the share in Germany. French labour cost growth has far outstripped that of Germany and German exports have grown three times as much as French exports over the past decade.
France and Germany are, of course, aligned in one arena – global bond markets. Both countries can borrow at record low interest rates. But while such low rates are extremely helpful for France in the short term, there is little sign they reflect optimism about the French economy. Rather, they stem as much from broader global monetary, liquidity and regulatory conditions, together with continued strong demand for French government bonds from a deleveraging domestic economy.
Therefore to give Germany the assurance it will need to agree to permanent burden-sharing, France needs to press on with reforms, and to do so boldly and visibly. It needs to reduce the size of the state, lower labour costs and so improve competitiveness and boost medium term growth prospects. Put bluntly, France needs to make its economy more German, and it needs to do so as quickly as possible.
Some of the necessary measures may prove painful to implement in the short term, particularly against a backdrop of slow growth and high unemployment. But France needs to recognize that if it is to achieve its long held goal of deeper union and mutualisation of liabilities then it too will need to cede some sovereignty.
There are promising signs that the French government and corporate elite now recognise that reforms are essential. For example, the government prompted French unions and business organisations to reach a labour market reform agreement that was more radical than many expected. The details of that agreement suggest that French unions may be making the journey towards becoming more German – increasing their focus on employment rather than wages. But that reform, which finally passed through the French parliament last month, is only a first step. France has much further to go.
The prize for France of deeper union and mutualisation of liabilities is still within its grasp. And it may turn out to be the only way to save the euro. But to make it possible for Germany to take this final step, France must itself give up some sovereignty, and press ahead with reforms to reverse the recent and ill-timed divergence of its economy from Germany’s.