Hamish McRae: Why France must be more like Germany

Economic View

The drama of the politics gets in the way of the grind of the economics – and I am referring to this weekend of elections in Europe rather than all that stuff we had here last week. The starred alpha election is the one to choose the president of France, but there are also really interesting elections in Greece, which have become a test for democratic support for the austerity programme.

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There are some local elections in Italy that will give some sort of feeling as to the support for the "technocratic" government of Mario Monti. There will also be a local election in Schleswig-Holstein, in Germany, which will be watched carefully, though the next regional election in North Rhine-Westphalia on 13 May will be more important, for it is not only much bigger but is rather a "swing" region, encompassing new and old German industry.

As it happens I was in North Rhine-Westphalia last week at a printing congress in Düsseldorf. It set me thinking about the different paths the continent's two biggest economies, Germany and France, had taken since the euro was introduced and the implications of this for the leadership of the two over the next few years. Printing has long been one of Germany's strongest industries but has been making the difficult adjustment from offset to digital and encapsulates the huge effort the country has had to make over the past decade to crunch down its costs, maintain its quality, and become even more competitive. Taken as a whole, German industry has made a quite remarkable recovery from recession, by contrast not just to the laggards of Europe but also to France, which has in many ways been a success story. You can see this divergent performance in industrial output in the main graph.

It is not very scientific to assert this, but the general perception was that when the euro was introduced Germany went into the new currency at too high a rate, France at about the right rate, and Italy and Spain at rather too low a rate. So Italy and Spain received an artificial boost to their economies, stemming not just from having lower costs but also because of access to much cheaper credit than they had previously been able to obtain. Germany, by contrast, struggled. It took the best part of a decade for the country to regain its competitive edge. You can see the effect of this in the small graph. In the early years of the euro Germany had higher unemployment than France, whereas now it has much lower. It is a pretty astounding contrast.

What Germany did was to bring in a wave of reforms, when Gerhard Schröder was chancellor, many related to the labour market, which caused short-term pain but brought long-term advantage. The country also held down consumption – there has been hardly any increase in German living standards over the past decade – and while it broke the Maastricht rule on the budget deficit, it has under Angela Merkel regained fiscal discipline. It has also kept the overall level of public spending under control. In France public spending accounts for 56 per cent of GDP, whereas in Germany it is 45 per cent. So you could say that the next president of France will need to do what two German chancellors have done – bring in economic reforms and curb public spending – and that while Nicholas Sarkozy made some sort of start on these reforms, compared with Germany the job has hardly begun.

At the moment the main debate about the future relationship between Germany and France has been in terms of their vision of a future Europe: the more austere ideas of Germany and the more relaxed ones of France. France has been urging a looser monetary policy from the European Central Bank, some pooling of eurozone debts and so on, though the previous French head of the ECB was more hawkish than its present Italian incumbent. That tension will continue; indeed it may intensify as austerity fatigue sweeps across Europe. You can make a decent argument for less-stringent economic policy if it is being used to buffer the shock inflected by structural reforms. On the other hand if the softer approach to policy is merely used to postpone the need for reform, then of course it has a perverse effect.

Given the anguish of the eurozone at the moment, the probability of a rescue being needed for Spain, and something really disruptive happening in Greece, this focus on Europe as a whole is quite understandable. But it seems to me that the domestic economic stories of France and Germany are just as interesting as the wider eurozone one.

For Germany, the line is set. It is now benefiting from its decade of austerity and while the most recent forward-looking data have been slightly darker than the previous industrial surveys, there does seem broad political support for the line the country has taken. Chancellor Merkel has another year of office. The dissent in Germany has come less from the public and more from the Bundesbank, which has become increasingly alarmed at the contingent liabilities that the country has been taking on one way or another as a result of eurozone imbalances.

In France? Well, the game is fascinating. Many of the long-standing strengths of the country are as solid as ever. We in Britain tend to be unaware not only of the excellence of large French companies but of the solidity of its service sector. But that unemployment pattern shown in the small graph is profoundly disturbing. In terms of fiscal management the country is exposed. Its fiscal deficit may, at the moment, be smaller than ours, but it has not run a surplus for the past 30 years and I have seen some projections that suggest that the debt-to-GDP ratio will run way over 100 per cent of GDP within three or four years. More than half of France's debt is owned abroad and, unlike the UK, France cannot devalue and reduce the real burden of debt in that way.

Could the French become more like the Germans? And if not, what then?

John Lewis's success story is no mirror to high street conditions

One of the rather few bright spots on the horizon has been the performance of John Lewis group, which includes Waitrose. We get weekly sales figures from the department stores, which have traditionally been taken as an early indicator of what is happening on the high street more generally. Unlike the normal official numbers these are actual ones, the cash that has come in at the tills, and they are extremely timely.

But they are just one group and the fortunes of John Lewis have increasingly diverged from that of retailers more generally. Thus sales during the week to 28 April were up 32.4 per cent on the same week of the previous year. That followed gains of 16.5 per cent, 13.9 per cent and 27.5 per cent over the previous three weeks, which is pretty astounding. There were special factors, including the timing of Easter and the royal wedding last year which held things back. The digital switchover in London and the South East has also greatly boosted sales of TVs. The company also has more stores trading. But it is still impressive, and as Howard Archer at IHS Global Insight noted: "Even allowing for a number of factors boosting the year-on-year growth rate, this is another very impressive sales performance from John Lewis that defies the UK apparently being back in recession."

But he also notes that John Lewis has been very much an outperformer and headwinds remain strong. He is right of course and it would be absurd to generalise about the state of retailing from one upmarket group. But this does seem to me to demonstrate the long-standing characteristic of British consumers: that if they are given an excuse to go and spend money they will. The problem is that with real incomes still falling they don't have many excuses. Not a lot is going to happen until inflation comes under control, we should all hope, this year.