Euro Zone: Germany Could Drag France Down

When the euro was launched in 1999, European policymakers said it would drive the Continent's leading economies closer together. But the news from Germany and France, which account for 51.3% of euro zone real gross domestic product, suggests the opposite is happening.

According to Deutsche Bank, the German economy will be lucky to expand by 1% this year, while France's should grow twice as fast. Already, first-quarter GDP growth in Germany was 0.4%, compared with 0.8% in France.

France's superior performance is being driven by strong private consumption and heavy corporate investment. In Germany, growth is primarily the result of buoyant exports. Faced with rising unemployment, German consumers are reluctant to spend. And German businesses, frustrated by their government's inability to deliver structural reforms, are more inclined to invest abroad than at home. That means the recovery in Germany has less fuel to keep it going.

A Growing Gap FOr Two Labor Markets
In France, meanwhile, joblessness is declining, so consumers are more willing to buy. Plus, French businesses are more confident about the economy and government policy, so they are willing to invest more in new plants and equipment.

The imbalance between Germany and France could even undermine the Continent's nascent economic recovery. Germany, the euro zone's largest economy, could drag France down if growth doesn't pick up soon.

The divergence also makes policy-making more difficult for the European Central Bank. Its key interest rate, which has been kept unchanged at 2% for the past 12 months, is probably too high for Germany and too low for France. But under the terms of the Maastricht Treaty, the ECB has to base its monetary policy decisions on the economic conditions of the euro zone as a whole, so it can't give Germany the kick it needs.

The solution, say economists, is for Germany to reform its inflexible labor markets. But there is little chance of that happening before the next general election, not due until 2006. Given that, the gap between Europe's two biggest economies is unlikely to narrow anytime soon.

By David Fairlamb in Frankfurt

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