The Daily Update - France and Germany

Today France celebrates la fête nationale (or Bastille Day) and Emmanuel Macron is hosting Donald Trump at the celebration: Perhaps in another demonstration of his intent to make a mark in international affairs as well as domestic policy.  Once the festivities end the focus will no doubt return to Macron’s domestic agenda and how much of his policy rhetoric he is able to execute.

Last week, the Prime Minister Edouard Philippe committed to reducing the budget deficit within the 3% ceiling that the EU target and tax reform is seemingly still on the agenda for 2018: in spite of limited scope for budget ‘giveaways’ some reform of onerous property and wealth taxes is expected.  However, reform of the labour market remains a key challenge: in Q1 the unemployment rate was 9.6%, which is 2% above the pre-crisis low suggesting significant scope for improvement.

The French labour market is highly regulated: collective wage agreements cover most employees but only 8% of workers are members of a union.  Moreover, company level agreements can only differ from higher-level agreements if they favour the employee.  Macron’s reforms aim to go further than his predecessor’s and cap severance payouts and deregulate temporary contracts.  Over time these reforms should boost employment although it is a contentious area and is likely to be met with resistance.

Germany seems to have tackled this area to good effect in that its unemployment rate was higher than France in the early 2000s but it now it is much lower at only 3.9%.  Thomas Piketty suggests that France has been weak in investing in vocational training; less effective in its industrial specialisation and that the complex and onerous tax and wage burden has constrained employment growth in the private sector.

Interestingly, France and Germany’s productivity levels are not dissimilar.  Work by Piketty using OECD data, which takes GDP per hours worked in purchasing power parity (euros 2015), shows that for 2015 France (at €55) was practically at the same level as Germany and the United States.  It is also higher than the UK and Italy and higher than countries of comparable size and economic structure.  That said, in France a higher rate of unemployment is likely to exclude some of the least well qualified but even when Piketty adjusts for this (using the post 2005 German trend in hours worked and new jobs having productivity 30% lower than present jobs) the French productivity estimates fall but they still remain close to Germany.  Average hours worked per job are lower in Germany than France but the number of individuals employed per capita is higher reflecting France’s high level of youth unemployment in particular. 

While Germany has a positive employment backdrop its large trade surplus can be seen as a significant imbalance. Germany was effective in maintaining competitiveness post unification through wage freezes and taking advantage of Central and Eastern European countries entering the EU to boost its trade.  Its situation is also exacerbated by the euro: Germany, a strong creditor nation, has become locked into a relatively weak euro exchange rate (than had it retained the deutschmark).  The IMF’s 2016 External Sector Assessment noted that the German REER is undervalued by 10-20 percent and using their current account regression model with standard trade elasticities it is 10-15 percent undervalued.  But even factoring in an ageing population the German surplus (~8% of GDP) can be deemed excessive, especially so for a non-oil producing country of its size.  The European Commission’s own Macroeconomic Imbalance Procedure notes Germany’s ‘persistently high current account surplus’ remains an issue and ‘addressing the surplus has implications on the rebalancing prospects of the rest of the euro area’.  Policy remedies include measures to boost domestic consumption and investment.

But given Germany’s May trade surplus reached EUR22bn (released earlier in the week) the issue is likely to be hotly debated in coming months, especially with the Trump administration.