Blog Marcel Fratzscher of December 28, 2023
While the French economy demonstrates remarkable resilience, Germany’s growth engine appears to be sputtering. But the two economies are more interdependent than ever, and their size implies that they must work together to reform and strengthen the European Union if they are to assert their influence globally.
BERLIN – The contrast between the French and German economies has rarely appeared so stark. While France continues to enjoy surprisingly strong growth and is increasingly attractive to both foreign and domestic investors, Germany is struggling – even if it is far from being the sick man of Europe – owing to a severe political crisis that has cast a shadow over its economic outlook and is weighing heavily on economic sentiment.
But this interpretation overlooks a fundamental fact: Germany and France are more interdependent than ever. To maintain economic growth and assert their influence globally, they must work together to strengthen the European Union.
The French economy demonstrated remarkable resilience during the COVID-19 pandemic and the 2022 energy crisis. Over the past two years, France has boosted its competitiveness, improved its business environment, and attracted more than twice as much foreign direct investment as Germany.
By contrast, Germany’s declining competitiveness has forced it to rely on substantial subsidies to lure international investors and support its own industry. Consequently, while France is expected to grow by 1% in 2023, German GDP is expected to contract, followed by minimal growth in 2024.
Germany’s complex federal system, known for its robust checks and balances, was designed to cement its democratic principles and prevent a return to authoritarianism. As such, it prioritizes stability over speed and flexibility. This preference is now taking a toll on the economy, as Germany urgently needs to implement major regulatory, fiscal, industrial, and trade reforms.
Another critical difference between France and Germany lies in their different approaches to economic openness. Germany’s postwar economic model has relied heavily on exports, which now account for nearly half of the country’s total economic output. This model has been shaped by political forces, foreign-policy preferences, and – before the euro – by monetary policies centered around a strong Deutsche Mark.
These diverging trajectories can be attributed to three main factors.
First, the French presidential system allows President Emmanuel Macron to set clear priorities and implement new measures quickly. This has enabled Macron to pursue major reforms of France’s pension system and labor market, streamline existing regulations, and establish bold industrial-policy goals that are now beginning to yield significant returns, including steady declines in unemployment.
Meanwhile, Germany is grappling with political gridlock. The so-called traffic-light coalition – comprising Chancellor Olaf Scholz’s Social Democratic Party, the Greens, and the Free Democrats – is failing. Deep ideological divisions have led to a political impasse that is threatening to paralyze the country, reflected in the government’s ongoing struggle to finalize its 2024 budget.
Moreover, Germany’s economic and fiscal policies have historically favored the industrial sector, from automobiles to chemicals and mechanical engineering. This fixation has led German politicians to focus on boosting the industrial sector’s share of economic output, which is currently nearly double that of France.
Despite these differences, the economies of France and Germany have far more in common than is generally acknowledged. While France has outperformed Germany over the past four years, it is still catching up to the remarkable economic boom Germany experienced in the 2010s. Notably, Germany has one of the lowest unemployment rates in Europe, and its companies have maintained their strong global market shares.
Moreover, in response to the pandemic, the war in Ukraine, and heightened geopolitical tensions, both Germany and France have pursued increasingly protectionist economic agendas.
Both have adopted national industrial policies that involve subsidizing domestic companies through reduced electricity prices, direct financial assistance, and various tax benefits, and have effectively launched a subsidy race to attract foreign investors and multinational companies such as Tesla and Intel.
These measures are unfair to companies in weaker European economies, reduce competition, and risk undermining the single market, the EU’s most significant economic achievement.
Both countries also have robust social-welfare systems in need of immediate reform. As inflation fuels social polarization and political discord, far-right movements are gaining ground.
The wave of populism and right-wing extremism engulfing many Western democracies is now heading for Germany. With the far-right Alternative für Deutschland (AfD) on course to win three key state elections in 2024, Germany could be facing an even deeper political crisis.
Lastly, both Germany and France are threatened by the escalating geopolitical rivalry between the United States and China. To maintain economic growth, both countries must move away from nationally oriented economic and fiscal policies and work together to reform and strengthen the EU. The latest reform of the Stability and Growth Pact is insufficient to foster investment and the transformation of the European economy.
On their own, the French and German economies lack the necessary scale to compete effectively against the world’s two largest economies, especially in critical emerging sectors like artificial intelligence and digital services. Both governments would be wise, therefore, to focus on their similarities rather than their differences.
Instead of competing against each other, they should unite around a common cause. After all, the prosperity France and Germany enjoy today can be largely attributed to their close partnership over the past 70 years, which has been instrumental in advancing Europe’s economic interests.
Faced with strong opposition from Germany, Macron seems to have abandoned his ambitions to reform Europe. This is a mistake. Both governments should change course and bolster the EU’s single market, complete the banking union, pursue capital-market union, develop a joint industrial policy, and streamline regulation and bureaucracy.
And, not least, a common fiscal capacity is vital for crafting economic and industrial policies that embody European values and objectives.