Winning the Economic Battle

Hans-Werner Sinn
The New York Sun, 02.05.2007

The new president of France, be it Nicolas Sarkozy or Ségolène Royal, will face a tough challenge when it comes to putting the French economy back on its feet.

While the world economy is booming for the fourth consecutive year, with a historically unprecedented growth rate of about 5%, the French economy is limping. In 2006, it grew by only 2.2%, while growth rates of only 2.1% and 1.9% can be expected for 2007 and 2008, respectively, according to a recent forecast by the German Economic Research Institutes. This is significantly below the average of the old EU countries for these three years — 2.7%, 2.6%, and 2.4%, respectively.

France is currently one of Europe's laggards, only slightly ahead of Italy and Portugal. Even Germany is performing better. With a growth rate of 2.7%, the German economy clawed its way back to the average of the old EU countries in 2006, and it can be expected to grow at 2.4% in 2007 and 2008, far faster than France.

France's meager growth is surprising. Until recently, the economy was doing fairly well, outperforming many EU countries. While Germany grew by only 14% in the 10 years from 1995 to 2005, ranking as Europe's "vice-laggard" next to Italy, France grew by 23.6%, which was nearly the old EU countries' average of 24.3%.

In 2001, France's gross national income per capita overtook that of Germany, and is now 4% higher. And yet recent growth figures seem to have reversed this trend for the time being.

French employment data has been worrisome for even longer. In 2006, France's unemployment rate was 9.4%, a full percentage point higher than Germany's. By 2008, the French rate can be expected to decline only to 8.2%, while German unemployment is anticipated to fall to 6.3%.

A similar pattern holds for public debt. While Germany has resolved its debt problem insofar as it no longer violates the European Union's Stability and Growth Pact and can be expected to have a balanced budget in 2008, the forecasts for France imply deficits of 2.6% and 2.3% of GDP for this year and 2008. If the boom in the world economy falters, France will again violate the Stability and Growth Pact, as it did in 2002, 2003, and 2004.

Why are France and Germany behaving so differently during this global boom? Among the potential explanations, the dissimilar specializations of each country stand out. While France has specialized in consumer goods such as food and pharmaceutical products, Germany is a leading exporter of investment goods. As the current boom in the world economy is largely fueled by investment demand rather consumption demand, only Germany profits from it to full measure.

Germany is the tool-shop of the world, with 450 world market leaders in niche products and another 500 companies in the top-three category. Fifteen of the world's 20 biggest trade fairs, measured by indoor exhibition space, are held in Germany, and the country tops the list in world commodity exports. Small wonder, then, that Germany's economy rockets when the world's demand for capital goods soars.

True, Germany has its share of problems. The country is gradually turning into an industrial bazaar that is relocating its workbench to low-wage ex-communist countries. This is one of the reasons why the boom of 2006 was incapable of creating additional jobs in German manufacturing, why Germany still has the Organization for Economic Cooperation and Development's highest unemployment among low-skilled workers, and why aggregate full-time employment has not yet returned to its level in 2000.

The French economy could be slightly more stable in the medium term insofar as it seems to have more solid internal sectors. But Germany definitely is partaking more of the current boom than France does.

Perhaps one French mistake was to neglect its small and medium-size firms and specialize too much on state-controlled mega-companies. Airbus, Renault, Crédit Lyonnais, and Alstom are wellknown examples of a mistaken industrial policy that has wasted French taxpayers' money — and that is partly connected with the name Sarkozy.

The true problem for France is the huge chunk of state-owned companies that go through the motions without being particularly successful in the market. In France, 25% of dependent employees work in the government sector, compared with 19% in the old EU and 12% in Germany. The French government share in GDP is 54%, while Germany's is only 47%.

In France, more than 7% of voters cast their ballots for Trotskyite and Communist candidates in the first round of the presidential election, while the Socialists, who received 27% of the votes, are much more left-leaning than Germany's Social Democrats.

Dirigiste attitudes are more popular in France than in most other European countries. To the extent that these attitudes may have led to a political system in which small and medium-size firms find it difficult to flourish, they may have contributed to France's problems.

It remains to be seen whether the new French president will be able to embark on a more promising course. The odds are not good. Ms. Royal will do nothing to increase the flexibility of the French labor market so as to facilitate structural change and enable new firms to be created, while Mr. Sarkozy is likely to continue to support France's lumbering giants, as he as done so frequently in the past.

Sound policy aimed at reviving the economy seems beyond the grasp of both candidates.

Mr. Sinn, a professor of economics and finance at the University of Munich, is president of the Ifo Institute.

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