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German authorities should embrace French demands for stimulating growth in Europe. Germany has always had a tendency to suffer from structural stagnation. Germany’s product portfolio is about to become out-dated and its supply-side advantages are eroding. Indeed, the German economy relies much less on comparative advantages than it does on demand from within the euro area. Thus, if the euro area disintegrates, Germany’s trade surpluses will dwindle and it will lose out.
The Germans could actually benefit by following France’s example in sustaining productivity growth, which Paris has done much better than Germany in the past. Indeed, Germany’s comparative advantage might erode as a result of the high influx of cheap euroflight capital. This though might even aid the European recovery process as a whole – and ultimately Germany, too. In the end, it is in Germany’s interest to do more to help the south overcome its present difficulties instead of burdening it with ever more debt.
France, on the other hand, has to take German competitiveness as a benchmark, but not the German model as such. It must accelerate growth because it must create more jobs, especially for young people. Yet at the same time it has to reduce its budget deficit.
For that it has three options: A quick solution would grant generous tax deductions for investment in equipment and housing, somewhat similar to what Germany did immediately after unification to redress East Germany. The danger is that this may support demand for the non-tradable sector without improving competitiveness and end in an unsustainable asset bubble. The second option would, therefore, focus on the difficult task of restoring competitive levels of unit labour costs by fostering productivity combined with moderate wage restraint. A third option is a delicate balance of the two.