How to analyse heterogeneity in EMU : the case of

How to analyse heterogeneity in EMU : the case of
French/German economic policies
Paper prepared for the Foutth Pan-European Conference on EU Politics
25-27 September 2008, Riga, Latvia.
Homogeneity of national economic policies within a monetary union is necessary in order to
build a robust economic growth for all members.
However, the French-German example of the past decade underlines the fact that, in spite of
strong and long-time economic links, non-cooperative economic policies can still appear in
EMU, leading to potentially gloomy economic performances for the whole monetary union.
This article uses a political economy analysis’ framework based on four criteria (stemming
from the OCA’s theory) to reveal the depth of heterogeneity between the French and German
economic policies.
This situation finally emphasizes the need to reform the present EMU economic and
institutional framework, in order to take this heterogeneity into account, and to avoid non
cooperative economic policies.
Author :
Research fellow
Fondation pour l’innovation politique,
75007 PARIS
[email protected]
This paper was made possible by the OFCE’s (Observatoire Français de Conjoncture)
authorization to use GTAP data.
I – Introduction: What history tells us for a sustainable EMU
The last years have seen a debate engaged in several Eurozone countries to know if it was
desirable or not to leave EMU. It especially took place in France and Italy, where consumers
have been subjected to high inflation rates and poor economic growth. For them, the Euro was
the only one to blame for it, because it does not allow national economies anymore to use
competitiveness devaluation in order to artificially regain price-competitiveness.
Apart from being absurd, this debate1 on leaving EMU or not shows how difficult it is to
shape a monetary union that would be convenient to every country. Consequently, it is
strongly needed to reflect on possibilities to improve the functioning of EMU. Whatever good
would be the economic performances of the Eurozone at the European macroeconomic level,
it is important to keep in mind that past monetary union experiences on the continent did not
last that long, and therefore to explore the reasons for their failure.
The Latin Monetary Union (LMU) began in 1865 and included Belgium, France, Greece,
Italy and Switzerland. The first difficulty appeared when nobody could agree on whether to
choose bimetallism (gold and silver) or monometallism (only gold). The second one was the
non-cooperative economic policy of Italy, whose Central Bank emitted new bills to replace
old silver coins, without preparing their neighbours to it. As a consequence, the four other
LMU countries were flooded with Italian coins.
The diplomatic tensions arising from these events, along with World War I, finished
strengthening divisions that led to the end of the monetary union in 1925.
An other famous experience of monetary union is the Scandinavian Monetary Union (SMU),
which began in 1873 and comprised Denmark, Sweden and then Norway in 1877. Problems
arose with World War I, showing wide diplomatic differences between the three neighbours.
During the War, Denmark traded much more with Germany than Sweden did, preferring to
remain neutral. Contrary to Denmark, Norway helped the British with their navy fleet.
Afterwards, the two latter speculated intensively on the Swedish money, which was much
Leaving EMU implies political as much as economic consequences, for a country as much as for the whole
monetary union. Therefore, the accession to eurozone can be considered as irreversible. See for example
Eichengreen (2007).
stronger after the conflict than Danish and Norge ones. This finally led to a progressive
monetary divergence and to the end of the monetary union in 1931.
Non-cooperation is at the origin of the rupture of the LMU and SMU (Olszak, 1996). As
a consequence, facing the critics over EMU, it is necessary to pay a careful attention at
possible non-cooperative economic policies, and a reflection on EMU economic
framework. This paper is aimed at trying to create a useful framework in order to analyse
heterogeneity. In the next part, we will present the main theories dealing with adjustment and
sustainability in a monetary union. Then, we will study an example of economic divergence in
EMU, taken from the German and French economic policies of the last ten years, and the
responsibility of the economic and institutional framework of EMU in these policies. Finally,
considering this worrying example, we will conclude with a presentation of some solutions
for the economic and political sustainability of EMU.
II – Sustainability, and how to adjust to country specific shocks in a currency union:
1. Review of the literature about adjustment in a Currency Union, theoretical and
Joining a currency union (CU) implies its own benefits, as Robert Mundell ever set in 1961 in
his primary article. These are the decrease of transaction costs, the improvement of prices
transparency, the stimulation of competitiveness, the elimination of exchange rates
uncertainties and the soar of Foreign Direct Investment (FDI).
But the American economist also found a great difficulty for a country in joining an OCA:
adjusting to country-specific (asymetric) shocks. Leaving the monetary policy independent,
national economies can only use taxation to prevent and adjust to economic disruptions. That
is why Mundell asserted the necessity for economies to increase wage flexibility and labour
After this famous article, many economists studied currency unions, developing OCA’s
theories, i.e. the number of criteria a country has to match before entering a currency union, in
order to minimize potential asymmetric shocks to occur.
In 1963, Robert McKinnon proved that the opportunity to create a CU depends on the degree
of economic openness between two economies. The more they trade with each other, the
weaker asymmetric shocks will be. Six years later, Peter Kenen (1969) emphasized the
importance of product diversification. Obviously, each country has to develop a diversified
production, not a specialized one. If a sector experienced a disruption, the centralised
monetary policy could succeed much better than if this type of production was settled in only
one country. Finally, Cooper in 1977 and Kindleberger in 1986 published articles that dealt
with homogeneous preferences. They explained that a high level of international trade
between two countries reveals common economic preferences and that in case of a monetary
union, the closer the economic preferences are, the easier both countries face economic
shocks. In Kindleberger’s article, economic preferences are defined as economic policies
based on similar concepts/theories (the way two countries face unemployment/inflation
dilemma). Homogeneity of preferences is linked with cultural and geographical integration.
In fact, for the economists of OCA’s theories, joining a currency union is possible only for the
countries respecting some specific criteria, in order to cover the risks of future potential
country-specific shocks. Obviously, the longer the list of criteria is, the harder it is for a
country to join a currency union. After several decades of completing the OCA theory,
economists turned the currency union’s theory upside down, thanks to Jeffrey Frankel and
Andrew Rose.
Their 1998 original article explains that countries first had to enter a currency union before
complying to a list of criteria, which anyway would never be complete. Actually, the surplus
of trade and economic interdependence given by accession to CU makes the optimality
endogenous. Consequently, the economic cycles of countries inside the CU become
synchronised and, in a theoretical vision of economics, asymetric shocks disappear.
Frankel and Rose’s research, based on the gravity model, paved the way to numerous other
articles like Smith (2002) or Frankel and Rose (2002) that tried to calculate the impact of
monetary integration on international trade. The results are balanced. On the one hand, they
succeeded in proving that a “trade effect” exists indeed and they even could quantify it. But
on the other hand, the results are so different across the studies that it is impossible to
consider a single or an average figure for this “trade effect”. Results go from 1,46 for Smith
(2002) to 3,9 for Frankel and Rose (2002) ! The figures are even smaller in studies relying
only on EMU2.
Moreover, regarding business cycles, this is not clear whether empirics are getting the same
way as theories. Several studies demonstrated that European national cycles were
synchronising (Bordo and Helbling, 2003; Hanaut and Mouhoud, 2003; Darvas and Szapary,
2005; De Lucia, 2008). However, the beginning of the convergence is very different along
with the study. Some economists emphasize the synchronisation during the 1970’s, whereas
some others prefer to concentrate on the period after the Maastricht treaty signature.
On the contrary, many other articles stress the fact that it’s hard to detect any homogeneous
European cycle (Artis, Krolzig and Toro, 1999; Artis, 2007). Furthermore, it may be worrying
to read articles concentrating on German economic cycle. Fichtner (2003), for instance, shows
that the German asymmetric shocks may be closer to the American than to the European
member states ones. Flaig, Sturm and Woitek (2003) exhibit a weak correlation between the
German cycle and the one in other Eurozone member states. De Bandt (2006) emphasizes the
importance of German reunification as a major cause for the remoteness of the German cycle
from the other European ones.
Conclusively, adjustment to country specific shocks is still a matter of concern in EMU, and
needs to be studied.
2. Our theoretical framework: sustainability, country specific shock and heterogeneity
For OCA economists, a country specific shock occurring within a CU stems from a lack of
economic integration. This lack of integration comes from heterogeneity, and that is why the
latter must be reduced before the entry of a country inside a currency union.
The problem of OCA theories is that they never analysed how economic optimality can
evolve (i.e. the ability for countries in a CU to face asymmetric shocks) after the creation of a
CU – if we suppose that all OCA criteria are come up by all the applicant countries, so that
optimality can exist. They do not answer the question of sustainability. Frankel and Rose
See for example Micco, Stein and Ordonez (2003), or Mancini-Griffoli and Pauwels (2006).
answered this question by showing that integration endogenously created optimality, but their
estimation was not verified by empirical studies of business cycles.
Therefore, we can not consider trade integration to induce optimality. On the contrary,
we consider that a currency union, even if it’s a far advanced stage of trade integration,
can still lead to non-cooperative policies, when common mechanisms are not strong
enough to correct national policies. Even after several years of economic integration,
heterogeneity could still lay under common regional mechanisms, and we need a
framework to understand and make them visible.
As some economists ever managed (Torres, 2007), we base our analysis on the same basis as
OCA theories: heterogeneity (asymmetric shocks appear because of a lack of integration).
Consequently, we apply the four original criteria of OCA theories to study economic
Wages flexibility (basis : Mundell, 1961)
Economic openness (Mc Kinnon, 1963)
Sectoral diversification (Kenen, 1963)
Economic preferences (Kindleberger, 1986)
We focus on an empirical case of economic divergence during the 1997-2007 period of time:
German specific shock and its consequences for France, its first economic partner.
III – Frankel and Rose discussed: the evidence lying under the France/Germany
economic policies (1997-2007)
In the lack of empirical studies verifying Frankel and Rose’s intuition for the EMU
experience, it is important to consider how Germany’s (the largest economy of the Euro area)
economic policies evolved and what consequences it had on France.
Let us focus on the three shocks that lead the German economy towards several years of
sluggish economic growth during the nineties’ decade: the reunification, globalization and the
accession to the euro (Bilger and Rurgraff, 2004). The combination of these three shocks
created an asymmetric disruption of the German economic structures.
1. Reunification, Euro, Globalization: road to recession for the German economy
The Berlin Wall’s fall on the 9th of November 1989 has often been analyzed as “the end of
history” (Fukuyama, 1993), and more specifically the start of a new era for reunified
Germany made of freedom, economic growth, etc. On the contrary, following Lallemant
(2004) we prefer to talk about the reunification as the beginning of economic problems for
this country. In fact, the transfer of the economic, monetary and social model from the Federal
Republic to the former Democratic Republic was not enough prepared, as would later
recognize Wolfgang Wiegard, president of the Economic Experts Council (sometimes called
as the “Five Wise Men Council”).
Preparing the German unification, Helmut Kohl decided with his finance minister to choose
the 1:1 parity to convert East-Mark into Deutschmarks. The openness of new financially
solvent markets in East Germany had to spread new waves of investment in the whole
country, to absorb unemployment in the West and to engage economic catching up in the
East. But this virtuous cycle never happened.
Because of the conversion of East-Marks into Deutschmarks, the wages were artificially over
evaluated, mainly because of the very weak productivity in East Germany (coming from
under qualified workers and obsolete fixed capital). This phenomenon dragged down the
competitiveness of East German companies, and the fall of industry output. In a second phase,
West German companies anticipated the cost of reunification, and decided to relocate
elsewhere in Europe. The German public debt expanded from 42 % in 1989 to 61,3 % of GDP
in 1997 (Gougeon, 1998), at the same time that companies were leaving the country and that
fiscal outcomes were decreasing. Therefore, the part of German trade in international trade
diminished gradually, from 11,7 in 1989 to 9,8 % in 1997 (Husson, 2005). The vicious circle
was on its way, and had a strong impact on the German economic performances during the
past years. For the European Commission (2002), the reunification caused two thirds of the
growth difficulties Germany has been suffering since the end of the nineties.
The second shock we must consider is the effect of economic globalization on the German
Some of the most famous characteristics of the German model were strongly questioned in the
nineties. The “join management” method, or the traditional research of a consensus inside the
company, was reconsidered by economists and journalists in a period where rapid decisions
had to be taken. Workers and companies had to adjust to globalization, so the past German
managerial methods have to evolve towards Anglo-Saxon strategies. In this context, a new
generation of managers emerged and took the power in companies that were the symbol of the
German power: Jürgen Schremp in Daimler-Benz, Jürgen Dormann in Hoechst. Then,
German companies started to relocate some parts of their production outside Europe, and to
fire lots of people: from 20 000 in the automobile sector between 1990 and 1996, to 40 000 in
Hoechst between 1994 and 1998 (Husson, 2005). Globalization also deeply affected the way
to finance investments. Whereas there was a strong traditional link between German
companies and national banks, the liberalisation of capital movements, as much as the
development of stock exchange, completely transformed economic financing. Gauer and
Scriba (1998) calculated that the investment rate was abated from 27.5 to 25.5 % of GDP
between 1982 and 1994. The authors also proved that there exists a negative correlation
between stock exchange capital and private investment, in the majority of developed
countries. As a consequence, the loss of German competitiveness during the nineties
cannot only be explained by the reunification, but also by changes induced by
The third shock Germany has been confronted to is the accession to the eurozone. EMU has
been a dilemma for the Germans. Losing a symbol of German power in order to create a
symbol of European construction? Some considered it as loss for the German identity,
whereas other insisted on the source of wealth coming from the creation of an EMU.
Unfortunately, 1999 (Euro on financial markets) and 2002 (Euro in paper money) destabilized
the German economy and this for three reasons. First of all, the convergence of interest rates
on a low level reduced the German price-competitiveness compared to its European partners,
who maintained lower interest rates (Bourgeois, 2005). Secondly, the Deutschmark has been
replaced by the Euro on an over evaluated conversion rate, which diminished the pricecompetitiveness of German products. Thirdly, a very strict instrument, the Stability and
Growth Pact, was created by Germany and supported by France in 1997 to supervise fiscal
policy from “traditionally expanding economies”. Actually, two of the Eurozone biggest
countries feared the increase of inflation from countries like Italy or Greece, where public
debt was particularly high and that needed incentives to reduce their public expenses. The
problem is that this instrument has turned into a drawback of European economic framework
for its creators. Even if they did not formally respect it, the SGP has always been a burden for
France and Germany economic policies and still is to this day.
These three shocks taken together can be seen as one big asymmetric shock, because of their
interdependence and their responsibilities for Germany’s bad economic performances. It is
not to say that they were properly country specific shocks and that they touched no other
European country. They did hit France economy too, but not to the same extent. For example,
France did not face relocations, a drop of investment, and a rise of its public expenses as did
Germany because of reunification. On the contrary, the three shocks (reunification,
globalization and adoption of the euro currency) induced the collapse of German
2. The German response to the asymmetric shock: non-cooperative policy burdening France’s
performances (1997-2007)
German competitiveness was hit by three shocks during the last thirty years. As a
consequence, unemployment developed and the economic growth was sluggish (with
recession in 2003). The response of the government – the non cooperative policy – has been
engaged since 1998 under the Schröder government and has continued by the coalition
between the CDU/CSU and SPD parties since 2005.
Supported by the political consequences of the weak economic growth during the early
nineties, the Schröder government undertook to reform the German model.
The first measures aimed at increasing the flexibility of the labour market. The Hartz I and
Hartz II laws created a new part-time employment agency, which helped companies to adapt
their number of employees with their needs. Unemployment benefits were reduced and
income taxes dropped from 25.3 (minimal bracket) and 53 % (maximum bracket) in 1998 to
15 and 42 % in 2006 (Rugraff, 2006). This supply policy was strengthened by the measures
included in the 2010 Agenda. Thanks to this program, several new rules enlarged the room for
manoeuvre for German companies. For example, the necessity for them to fire the youngest
employeee before the oldest one was cancelled. Then, the laws Hart III and IV made
unemployement benefit harder to get and reduced their amount. As Metchild Veil explained3 :
“[…] the new protection system means a clear deterioration compared to the previous
situation [concerning people benfiting from this type of income], as much in financial terms
as by the inflection of the system”.
The results of legislative elections of September 2005 put Angela Merkel new chancellor of
Germany. The most disputed reform its government implemented was the rise of Value
Added Tax (VAT) in January 2007, from 16 to 19 %. Analysed as an isolated measure, this
rise enabled the government to reduce public expenses which was one of the major priorities
during the electoral campaign. But replaced in the whole political program of the coalition,
the competitiveness aspect appears more clearly. Indeed, this measure was accompanied with
a fall of employer’s contributions of 1.6 point. This adjustment method which is based on
libertarian theories favours German companies selling products abroad (they pay less
taxes) instead of foreign ones selling products in Germany.
Consequently, the countries suffering the most from this non-cooperative strategy are
Germany’s first trading partners: France, Italy and Spain. Actually, one of the leaders of the
European construction uses its tax system to allow German companies to regain the
competitiveness lost because of the three shocks described above. It is an artificial way to rise
German exports and to win market shares on the back of its major trading partners. Following
Creel and Le Cacheux (20064), we can call this particular economic policy a competitiveness
disinflation. Figure 1 below shows the incredible ascencion of German exports during less
than ten years, compared to the modest evolution of French and Italian exports.
Veil M., (2005), « Les lois Hartz : plus qu’une réforme du marché du travail ? », Chronique internationale de
l’IRES, n°92, janvier, p.10.
For the theoretical litterature on competitiveness, see for example Blanchard and Muet (1993) or Lordon
Figure 1: Evolution French, German and Italian exports (1998-2006)
Source : Cancé R., Montornes J. et Ourliac B., (2006), « Zoom sur l’économie allemande :
l’Allemagne se qualifie pour la reprise », INSEE, division synthèse conjoncturelle, juin, p. 33.
This non-cooperative strategy also induces negative effects for economic growth in neighbour
countries. If German companies get market share abroad, and harms internal demand inside
the country, it may have two kinds of drawbacks for neigbour economies: first, German
companies take market shares on European ones, inside the single market (and even outside
on international markets on which they are in competition); Secondly, European economies
selling a large part of their production on German markets may face a slump in the external
demand of their companies. Both of these effects may involve serious consequences for the
economic growth in Germany’s first trading partners.
We can see on Table 1 below the consequences of the German strategy on the four largest
economies of the Euro area, calculated by the French research institute the Observatoire
Français de Conjoncture Economique (OFCE). In the middle term, advantages are
substantially positive for the German growth and negative for its first trading partners,
especially France.
Table 1 : Consequences of the German strategy on the four largest economies of the
Euro area
Market Shares Imports competitiveness Internal demand Total
Source : OFCE, (2006), « France : le coût d’outre-rhin – Perspectives 2006-2007 », Présentation pour la
conférence de presse, mardi 25 avril.
Our purpose is not to prospect if this economic policy would be good or not for Euro area’s
long term economic performances. The main interest here is that the German noncooperative policy emphasizes and is supported by heterogeneity between France and
Germany. This strategy can be analysed thanks to the four heterogeneity criterias presented
Heterogeneity of economic preferences (on EMU economic framework)
The non-cooperative economic policy implemented by German government since 1998 has to
be understood with German historical economic preferences. This country has built its
prosperity during the 20th century on a particular capitalist model. The latter is defined by
different elements, including the “join management” system, and a strong Welfare State that
coexists with competitive markets (Albert, 1991; Rugraff, 2006). The participation of federal
economic policy in managing the business cycle is limited by the importance of the “Länder”
and the national constitution, which prevent the negociations between trade unions and
businesses from the participation of the Federal State (unless in particular situations).
The independance of the Central Bank, which is a particular element of the German
constitution, compels governements not to rely on competitive devaluation in order to
stabilisize the economy when disruptions appear. Concurrently, the Bundesbank built its
authority on mainly two elements during the last decade: a strong currency (the Deutschmark)
and price stability.
To have a strong currency is a symbol of power for this country, as Angela Merkel repeated
during the winter 2007/2008, whereas price stability is a heritage of the post-war
hyperinflations era. In fact both come from German history (Kogej, 2007).
The hyperinflation periods left a durable mark on the society. Naturally, the fear of inflation
was then incorporated in German economist’s theory (ordo-liberalism) and in political and
economic leaders, which were strengthened, in turn, by the failure of the Weimar Republic
and the Thrid Reich (Nicholls, 1994). Ordo-liberalism theory was developed during the postwar period, in particular the Freiburg School. This theory considers the State only as a
regulator, aiming at developping freedom in the market and a reduced but efficient social
balance. Ludwig Ehrard, the first Economics Minister of the post-war era, was influenced by
them. This dominant domestic ideology conditioned and constrained the way key policy
makers negociated and influenced the Maastricht conference (Dyson, 2000) and supply side
reforms as long as market liberalization constituted the basis of German economic policies
during the eighties and the nineties (Gougeon, 1998).
As a consequence of these two elements (tradition of Ordo-liberalism and Price
stability/Strong currency) and in the context of the European Monetary Union (Independence
of the ECB), the German economic policy could neither face the three shocks by relying on an
active monetary policy nor on an expansion of fiscal deficit.
The French monetary policy has never been so focused on price stability and strong currency.
During the 20th century, France used the monetary tool to devaluate the Franc in order to
maintain the competitiveness of its industry, in 1977 and 1981. The role of economic policy
was to stimulate activity, and not to prevent from inflation. Increasingly, economic policy in
France has always been marked by a centralisation of power, sometimes called “tradition
républicaine” (Maes, 2002). For example, after World War II, the creation of the
“Commissariat Général du Plan”, a national planning office, was aimed at reducing
uncertainty by fixing orientations to economic actors, based on medium-term previsions.
Moreover, whereas in Germany economic policy was strongly influenced by liberalism,
France was rather concentrated on applying Keynesianism principles during the first decades
of the post-war period (Rosanvallon, 1987). The French preference for an active monetary
policy as long as a centralisation of power, shaped the French model and widely influenced
the French positions during the Maastricht treaty negotiations. As a contrary, Germany was
influenced by a different model: ordo-liberalism (Maes, 2002).
Today, divergences between the French and German visions of economic policy continue to
live, though they are the two first trading partners in the European Union.
For about two years, French economic and political leaders have strongly desired ECB to use
its interest rate as an economic tool, evolving with inflation and economic growth, as the Fed
does in the USA. Critics against the ECB came with the first rise of the Euro in 2006. Then,
during the presidential campaign, both left wing and right wing candidates criticized the
European monetary policy for its rigidity and the importance it attached to price stability.
These critics did not stop following the election of M. Sarkozy. For example, Mr Fillon, his
prime minister, proposed to organize a meeting during the 2008 summer with Economic and
Financial aiffairs ministers of the Euro area, in order to improve the Eurogroupe functionning.
During the French presidency of the EU, President Sarkozy as much as Mrs Lagarde, the
minister of Economic affairs, advanced in many speaches the need to strengthen coordination
between ECB and Economic and Finance ministers within the Euro area, proposals to which
the German governement is firmly opposed. The difference of opinion between France and
Germany concerning the management of monetary policy is not recent. At the beginning of
the nineties, “ordo-liberals were on the whole unhappy with debates about EU-level economic
policy ‘co-ordination’, preferring ‘dialogue’ and ‘co-operation’. Their particular suspicion
was directed at French talk of an ‘economic government’, at references to a more active
exchange rate policy for the euro […]5”. Today, the deate is still living.
It is easy to note a deep and lasting heterogeneity between France and Germany concerning
inflation/unemployement dilemma finds its answer in the importance given to inflation and
the need of a rigid monetary policy, because of several events in German history.
In France, monetary policy is rather used as an economic tool. This preference may come
from the tradition of centralising economic policy, where this is the opposite in a Federal
State like Germany. Since the tradition of a independent monetary policy is firmly rooted in
Dyson K., « Germany and the Euro : Redefining EMU, Handling Paradox, and Managing Uncertainty and
Contingency », Queen’s Papers on Europeanisation, No.6/2000, p.3-4.
German’s political and economic consciousness, and because of the inability to use fiscal
policy (in the end of the nineties, public deficit was too close to the Stability and Growth Pact
thresholds), governments decide to rely on wages lever to help its industry to regain its
Flexibility of real wages
Competitiveness disinflation is leant uppermost on the decrease of prices, given by the
deterioration of wages conditions. Germany deregulated its labor market thanks to political
measures taken between 1990 and 1998. This situation was allowed and amplified by the
particular wage setting system in Germany.
Now, this German model is far from the French one. Beyond the heterogeneity analysis
between both countries, related to the wage element, it is possible to emphasize the possible
differences of economic responses in case of a country specific shock, thanks to the German
example of the last decade.
Within the German system of co-decision, Welfare state cannot intercede in wage bargaining,
except in some particular cases, « as a last resort ». The wage setting system depends, like
professional training, on branch unions bargaining, which establish collective agreements. At
a national level, incentives can appear, depending on the political context, but whatever may
be the willingness of the unions, they are not judiciary able to engage in bargaining, outside
the sectoral level (Bosch, 2002). At the same time, strikes are strictly regulated and rarely
happen. As a consequence, wage flexibility partly comes from the lack of judiciary
institutionalism at the national level (Mazier, 1999).
The decentralization of wage policy, which is a strong element of the Renan Capitalism, is
based on high unionization rate. Along with the globalizing economy and the evolution of
management standards, several researchers predicted a collapse of the German wage setting
system during the 1990s (Streeck, 2001). On the contrary, it seems that even if syndicalism
rate is decreasing, German companies and trade unions are still clearly attached to this
traditional system (Thelen, 2000). After the reunification, « the German system adapted itself
to the new economic framework but preserved its ability to define compromises based on
mutual concessions »6.
Wage flexibility resulting from this system is based on a constant adaptation to short term
economic evolutions, thanks to decentralized branch agreements (Boyer, 1986). Since the end
of the 1990s, in the context of the search for competitiveness in Germany, trade unions in
exporting sectors found a consensus on a wage freeze and on a increased flexibility. German
companies being composed of thousands of small and average size exporting companies,
wage freeze touched a large part of the German industrial sector. The Figure 2 below
underlines the fact that German companies got the possibility to diminish the wages after the
recession of 2003, whereas everywhere else in the European Union, they increased or stayed
the same.
Figure 2 : Evolution of wages in France, Germany, Italy and in the EU
Source : Hans Blöcker Stiftung Institute, 2006 (Graph is reproduced from Drouin, 2007).
Mazier J., (1999), « Les grandes économies européennes », Repères, La découverte, Paris, p.34-35.
Even if the two countries are geographically close to each other, the French system is far from
the German one. In France, the wage setting system is characterized by centralization, ie the
place of the State. Following Mazier (1999): « Due to the break-up of social relationships, the
State exerted a strong influence on the management of wages relations »7. This centralization
comes from the French governments efforts to combine social and economic planning after
the World War II, with instruments like the Commissariat Général du Plan. For example, the
place of the State during the 1960s was so strong that, under the Fifth Plan, the framework for
public sector wage negotiation caused controversy, « because trade unions had played no part
in negotiating this ». After the social break-up of 1968, governments tried to rebuild labour
market regulation, and politics and laws continued to determine the framework for social and
industrial decision during several years (Barrat, Chaput, Naboulet and Wolff, 2007).
Since 1970, a minimum wage, the SMIC, has been institued, initiated by the socialist
government which concluded an agreement with social partners. Thanks to this instrument,
wages are theoretically less flexible than in Germany and the risks for a poor workforce to
appear are minimized.
The special feature of trade unions/companies relationships in France seems to come from the
centralization of power in the country, the place of the State and from its economic history, in
which reaching a consensus has a weaker place than in the German model of codecision.
It is paradoxical to observe the easiness with which German trade unions accepted a freeze
wage, and the much more rigid model of bargaining in France. The competitivness
disinflation implemented in Germany during the last decade would not have been
transposable in France, all the more that French trade unions still keep in memory the
competitivness disinflation which durably weakened France’s economy.
There exists a strong heterogeneity between the two neighbours’ economies concerning wage
flexibility, in spite of fifty years of European construction. These structural differences can
induce an antagonism when adjusting to an economic country-specific shock. Indeed,
recommendations from the European Commission indicate that European countries have to
use labour market flexibility to adjust to a country specific shock or to gain competitivness.
Nevertheless, the Germany/France example indicates that this is not possible in the same way
Mazier J., (1999), ibid., p.36.
for every country. Germany adjusted to a country specific shock by using the flexibility
instrument whereas, it would not have been possible for France to use it to the same extent.
More worrying, Germany used the flexibility instrument recommended by the European
Commission, but engaged at the same time in a non-cooperative policy, gainning market
shares on its neighbour countries, reducing their future potential GDP.
Economic openess of France and Germany, and the importance of appearing small
The German strategy would not have been a success if the country were a closed economy.
Indeed, economic openess is an essential element of a competitive disinflation policy (Le
Cacheux, 2005). In the case of a very opened economy, the slump of incomes in the domestic
economy (coming from the rise of VAT or the lack of investment, for example) can be
compensated by the additional competitiveness provided by flexibility on the labour market
and freezing of wages (coming from competitive disinflation policy). In the case of a closed
economy, this may not be certain, if the competitiveness gains rising from labour market
flexibility are inferior to the provided additional external demand. We voluntary enlarge the
definition given by Kenen (1969). In his article, economic openess was defined as the ratio of
tradable goods to non-tradable ones. We prefer to add GDP in this measure, because we link
economic openness to economic size (see further). As a consequence, economic openness rate
of country i is calculated with the following expression:
ORi =
Xi + Mi
2 • GDP
Where Xi and Mi respectively stand for exports and imports of country i.
Economic openness is not equal in every country, and largely depends on the size of the
economy. Unfortunately, there does not exist a precise definition of this concept yet in the
theoretical economic litterature. Economic size can be appraised by superficy, GDP or
population criteria (Archer and Nugent, 2006). We will rely on Laurent and Le Cacheux
(2004) for its definition: a “small” country is defined as less than a quarter of the largest one
(in terms of GDP), an “average” country counts for less than a half of the largest, and the rest
being the larger ones. To that extent, the eurozone includes three large economies (France,
Germany, Italy), an average one (Spain), and eleven small economies (other countries).
Traditionaly, smaller economies are always considered more open than large ones (Archer
and Nugent, 2006; Rose, 2006). This can be easily explained by the necessity for a small
economy to import a large part of the needed products. Since smaller economies are more
open than larger ones, it would be less costly for them to undertake a competitiveness
disinflation strategy, benefiting from the advantages of size.
Empirically, this hypothesis can be partly verified in the Eurozone, thanks to table 2 below.
The larger economies (France, Italy) are more opened than the smaller ones (Belgium, the
Netherlands). The only exception is Germany. It would be logical for Germany to be as open
as Franc, considering their very similar economic size in terms of population and GDP.
However, paradoxically, Germany is relatively more open than France, with about the same
rate as Finland.
This element is structural, coming from the traditional preference of the country for
international trade, with a very strong industry. From the second part of the 19th century to the
1970’s, Germany asserted itself as the global leader of special manufactued goods, products
defined under the needs of the buyer, with minimum stocks8 (Piore and Sabel, 1989). Since
this period, the German economic policy has been constantly oriented toward acquiring
market shares all over the world, except during World War II9. For example, German exports
grew up from 8.3 to 15.1 % of national industrial production between 1950 and 1960, and the
part of West Germany in international trade expanded from 3.5 in 1950 to 7.3 % in 1957 to
10.9 % in 1965. The European construction strengthened this position, allowing the German
industry to benefit from a market of more than two hundred millions of consumers.
The construction of the specialization comes from several historical events. After the failure against Napoleon,
Germany settled a powerful military industry, with whom it will defeat France and Austria during the two World
Wars of the 20th century. A second occasion shaped the famous Rhenan Capitalism and its industry. In the end of
the 19th century, the appearance of American products on German markets activated a reaction of protectionnism
in the country, a law favoring German trust in 1897 and strong links entrenched between industry (machinery,
military industry), the Federal State and the banking sector.
Adolf Hitler prefered to build its German empire on autarky economy rather than international trade.
Table 2: Economic openness rate of Euro area countries, in 2005
Openness rate
Luxembourg 71,74
Source : OECD Database
Therefore, Germany’s economic openness is a structural element. In a competitive
disinflation, this element is consistent and useful. Wages reduction in Germany allowed
competitiveness gains and an increase of trade performances, whereas the same strategy in
France would not have been consistent with economic size.
Indeed, France is comparatively much less open than Germany, which can explain the
disaster of competitiveness disinflation in France during the 1980’s (Blanchard and Muet,
1993). Face to a weak economic growth, the French government decided after two inefficient
programmes (1975 and 1981) to implement a competitiveness disinflation policy. Inflation
sharply decreased immediately, and trade balance surplus appeared in 1992. However, the
assessment of this policy is far from positive. It entailed a long period of unemployment, with
hysteresis effects on the workforce; economic growth was inferior to the one within its
European partners from 1983 to 1987. Finally, market shares were conquered abroad but
mostly in European coutrnies, because the Franc was too high to generate an increase of
market shares outside Europe (Atkinson and al., 1993).
Heterogeneity between France and Germany can be also analyzed through the concept of
economic openness. The latter has important consequences on the strategies a eurozone
country can put in place if encountered to an asymetric shock. This element is perfectly
compatible with a competitiveness disinflation strategy for smaller countries, or countries
with a high openness rate.
Heterogeneity of production structures
Structural differences in economic preferences between France and Germany appear more
clearly recently with the quarrels between the two governments on the optimal euro exchange
These divergences induce a willingness to implement a different treatment of the
exchange rate policy (active for French, inactive for Germans). At the same time, these
divergences imply an important potential of country-specific shock to occur. This element is
emphasized by the heterogeneity of production between the two countries.
Industrial specialization mirrors the productive choices of a country. It expresses the extent to
which a country produces one category of goods more than another. Considering the
French/German example, both countries production structures are widely different all along
the 20th century.
The German specialization comes from the end of the 19th century (Piore and Sabel, 1989).
The industry was concentrated on manufactured heavy materials and equipment and did not
change much during the 20th century. The France specialization is broadly different. Before
the French production structure progressively looked like the US one (producing office
equipment, low manufactured products), whereas the German became more specialized (Piore
and Sabel, 1989). Then, with planarization, France became competitive on other sectors
(energy, aircraft, for example), whereas Germany did not really change its production
structure, simply including innovation in its traditional sectors. Thus, following Leblanc
(2007), we consider Germany to have a more stable specialization than France during the 20th
What is the current specialization of these two countries? To understand their position, we
calculate their production structures thanks to the Lafay index, extended to take into account
of world exports. In 1990, Gerard Lafay published an article in which he analyzed the
specialization of several national economies with a relative new index, far from the ones used
in production structures analysis10, including for example GDP values. In 1999, this
instrument will be improved in Lafay, Freudenber, Herzog et Ünal-Kesenci’s book to include
world exports. The index takes the following form:
 X − M ik   X wk + M wk
LAFik =1000 •  ik
 − 
 GDP   X w + M w
  X i − M i 
 • 
  GDP 
Where Xik is exports of product k from country i, Xi is total imports from country i, Xw is
total world exports and M are imports.
We apply this index to the two economies thanks to the GTAP database, providing
disaggregated data for 2001. The results, which are consistent with other studies on
specialization (Peridy, 2006 ; Leblanc, 2007, for example) are detailed in the table in Annex.
Database providing 41 categories of goods, we chose only to represent in the Figure on page
23 the results for the 15 most traded categories of products within international trade.
It is easy to note a strong specialization of Germany on motor vehicles and machinery
products, and to a lesser extent in the category of chemical industry (including rubber and
plastic). On the contrary, we only observe for France a weak comparative advantage in the
chemical sector, and no comparative advantage in motor vehicles and machinery. Conversely,
the French economy shows a weak specialization on vehicles and transport equipment,
whereas Germany exhibits a comparative disadvantage in these categories. Increasingly,
See for example Index used by Balassa (1965) or by Vollrath (1991).
specializations of the two countries are dissimilar on the sector contributing the most to
international trade: machinery, chemical products, transport vehicles, motor vehicles and
business services.
Considering heterogeneity of production structures, the conditions for adjustment to countryspecific shock will be different between the two countries, when a country-specific shock
occurs. German specialization is consistent with a competitiveness disinflation strategy.
Indeed, the economy is widely open and specialized on sector contributing the most to
international trade. Consequently, each competitiveness surplus for German companies is
strongly optimized by them, all the more that the German economy is characterized by the
important number of exporting firms compared to the French one (Lallemant, 2004).
Germany can use its specialization patterns within the EMU economic and institutional
framework, in order to adjust to adjust to an country-specific shock, by implementing an noncooperative economic policy.
As a consequence, production structures as much as wage flexibility, economic openness and
economic preferences, indicate a potent and structural economic heterogeneity between
France and Germany. This heterogeneity must be taken into account to avoid countries to
implement non-cooperative economic policies when they are confronted to a country-specific
Figure 3: Distribution of French and German Specialization on 15 sectors
(Lafay Index, 2001)
and Eq.
Chem. Transp.
Transp. Textiles
Source : GTAP database
Conclusion: Learning the lesson from the German/French policies to reform economic
The “Germany/France” example of the last ten years shows that heterogeneity between two
countries is underlying in the long as much as in the short term, even if the two countries are
historically the most integrated in a regional construction such as the European Union. In a
context of country specific shock (in Germany, here), if long term heterogeneity criteria meet
short term ones, it pushes countries to engage in non-cooperative policies, as Germany did
during the last decade. This non-cooperative policy makes EMU less sustainable, and can
create political and economic tensions between all the countries.
Obviously, this example does not mean that any economy will never be able to create a CU
with its neighbours, but that more than convergence criteria, the most important element of a
homogeneous currency area is its economic and institutional framework.
It would be ridiculous to explain Germany’s decision to implement a competitive disinflation
by saying that it deliberately choose to undermine French economy. The problem comes
partly from the heterogeneity of the two economies, but to the same extent from the
uncompleted economic and institutional framework of the Euro area, which does not take
structural heterogeneity into account.
For our purpose, optimality is not endogenous. The sustainability of EMU is linked to the
economic and institutional framework built above national economies, at the European level.
This framework is not complete for the moment and needs to be reformed. If it is not, EMU
may not be able to avoid non-cooperative policy from member states confronted to country
specific shocks.
Moreover, the purpose of this paper was to build a framework to study economic
heterogeneity in EMU. We based our analysis on criteria stemming from OCA theories, and
then focused on an empirical case (the three economic shocks in Germany). This framework
correctly fit the German/French example, but obviously need to be improved.
Paradoxically, there is not much theoretical economic literature dealing with heterogeneity in
currency unions, whereas EMU is constantly growing, including 15 member states at the
moment. The general aim would be to prevent Euro area from non-cooperative economic
policies, in order to make Euro area sustainable. And this is especially a necessity in France
and Italy, where larger parts of public opinion consider the European currency to be the
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sectors in internaitonal trade, 2001
International trade, in %
Machinery and equipment
Electronic equipment
Chemical products (inc. Rubber and 3,805
Transport vehicles
Motor vehicles
Business services
Transport equipment
Manufactured products (others)
Agri-indus. products
Wearing apparel
Metals nec
Paper products, publishing
Source : GTAP Database.