France is sick – but Germany is cured

Investment bank Morgan Stanley has timed exquisitely its decision to name France "the new ‘sick man’ of Europe". The run-up to a bitterly contested presidential election is the right moment to catch attention. Especially when, just across the Rhine, France’s chief competitor for economic leadership in the European Union is being feted for having successfully cast off the sick-man tag.

Look first at Germany. Last week Michael Heise, chief economist for Germany’s insurance/banking giant Allianz, presented a paper he had prepared for the Lisbon Council, arguing that Germany’s economic renaissance is far more than a flash in the pan. In 2006, after five years of stagnation, and the faintest hint of recovery in 2005 when gross domestic product (GDP) rose 1.1%, the German economy suddenly took off, with output rising by 2.1%. After an expected slowdown in the first half of this year, the result of a hike in value added tax rates, growth in 2007 is expected by Germany’s Ifo Institute to slip back to 1.7% before powering forward again in 2008 by 2.2%.

But it is not so much the macro-economic figures, more the micro-economic performance underlying them, which is exciting Heise. He describes Germany’s labour market performance, which saw 500,000 jobs created last year, as "downright sensational", another manifestation of the profound restructuring which he noted two years ago is going on at company level. It lifted manufacturing industry productivity growth to a remarkable 6.0% annual rate last year, has helped to restore Germany to its historic leadership role in world export markets. It is also helping to underpin domestic consumption and investment spending.

Spurred by Germany’s recovery, "in 2006 economic dynamism shifted from the US towards Europe" according to Ifo’s European Economic Advisory Group, with EU27 growth hitting 2.9%, the highest level since 2000.

But there is for Europe an increasingly worrying question-mark hanging over the US economic outlook.

On 27 February, former Federal Reserve Board chairman Alan Greenspan warned that there were early signs that the US could be slipping towards recession by the end of this year. It is not just that growth slowed more than expected in the fourth quarter of 2006. Worse, the rumbling housing market crisis has deepened as a result of the stupidity of lenders like Britain’s HSBC Group, who, in the past three or four years have lavished billions of dollars of loans on the "junk", or "sub-prime" home loan market, loans which are now going sour at a spectacular rate. American consumption (70% of the economy) has, since 2002, been underpinned by borrowing against housing assets, a process now winding down and hauling growth down with it.

It is uncertain how big a drag on world growth the US economy will in fact turn out to be this year (a slowdown has long been pencilled in by official forecasters such as the Organisation for Economic Co-operation and Development. So is the impact this might have on Europe and of course Germany. Many fear that what Charles Goodhart, speaking at a seminar organised by the International Monetary Fund and Bruegel, a Brussels-based think-tank on 21 February, dubbed a "golden era" for the world economy, could now be coming to an end, with unpredictable consequences. Economic forecasts for the next two years should come with a health warning.

This helps to explain the anxiety about France. Eric Chaney, a Morgan Stanley economist, points out that in terms of growth, France went from a "middle ranker to an underperformer" last year "without any particular macro-economic factor explaining the underperformance". He says that France has been losing export market share since 1999 and that its performance is now "alarming". He puts this down to "poor or slow adaptation to the rapidly changing [global economic] environment resulting from globalisation". Partly as a result, he says that France is now the "unemployment champion of the euro area". Government debt, he adds, is ballooning. It is an exception among Europe’s economies: "big government is alive and well" in France with "government outlays as a % of GDP [remaining] roughly constant at 54 % since 1995."

Chaney is not optimistic about the economic policy proposals the two leading presidential candidates are presenting. He worries that Ségolène Royal’s centre-left policies could initially boost consumption and inflation. Nicolas Sarkozy’s centre-right policies, he says cautiously, are less expansionary in the short term but could increase potential growth in the longer run and are more business friendly.

According to Heise, what is clear is that the far-reaching corporate sector reform which has been going on for several years in Germany is transforming the performance of German companies and this will put intense pressure on companies around Europe, notably in France, to reform too. The worrying thought is, that if, like too many EU governments, French companies are not making use of the "good times" to restructure, they will have to do the dirty work in the tougher times which may lie ahead.

• Stewart Fleming is a freelance journalist based in Brussels.

Investment bank Morgan Stanley has timed exquisitely its decision to name France "the new ‘sick man’ of Europe". The run-up to a bitterly contested presidential election is the right moment to catch attention. Especially when, just across the Rhine, France’s chief competitor for economic leadership in the European Union is being feted for having successfully cast off the sick-man tag.

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