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The European Review

By Patrick Artus, chief economist at Natixis

The core reason for asymmetry between the German and French economies: corporate profitability

Friday, 25 May 2012 Written by 
The core reason for asymmetry between the German and French economies: corporate profitability The main explanation for asymmetry between the French and German economies is that in France, companies’ production capacity is unable to keep up with domestic demand, whereas in Germany it is growing faster than domestic demand. This difference is related to corporate profitability: high and rising in Germany, but low and falling in France, which is limiting French companies’ investment capacity. There are two plausible causes for the profitability gap between German and French companies: the higher level of product sophistication and diversification that gives more pricing power to German companies; and the nature of labour market negotiations, where the link between the labour market and the economy is much stronger in Germany than in France. Yet – if no new economic policies are introduced to improve the profitability of French companies – it is more than likely that the country’s economic situation will not improve. http://www.ftseglobalmarkets.com/

The main explanation for asymmetry between the French and German economies is that in France, companies’ production capacity is unable to keep up with domestic demand, whereas in Germany it is growing faster than domestic demand. This difference is related to corporate profitability: high and rising in Germany, but low and falling in France, which is limiting French companies’ investment capacity. There are two plausible causes for the profitability gap between German and French companies: the higher level of product sophistication and diversification that gives more pricing power to German companies; and the nature of labour market negotiations, where the link between the labour market and the economy is much stronger in Germany than in France. Yet – if no new economic policies are introduced to improve the profitability of French companies – it is more than likely that the country’s economic situation will not improve.

The economic asymmetry between France and Germany

The main reason for economic asymmetry between France and Germany, which also explains the differences between their current account balance situations, is the ability of companies to build up production capacity to meet domestic demand.

Indeed, domestic demand in France has increased much faster than GDP meaning that its inability to meet excess demand through domestic production has cost them potential economic growth. And its production capacity for industrial products in particular has been unable to keep up with domestic demand. This is in stark contrast to Germany, however, where domestic demand is actually weak relative to supply.

The role of corporate profitability

A key explanation for the differences between German and French companies’ investment capacity is corporate profitability, particularly in the manufacturing industry. Indeed, corporate profitability has been growing in Germany but declining in France since 2000. This is because, unlike in Germany, French companies are faced with cost increases that exceed price increases, particularly in the industrial sector. Furthermore, French companies have been unable to pass on increases in production costs to consumers, explaining the long-run decline in profitability since 2001.

Indeed, the low profitability of French companies is an obstacle to investment that German companies are not lumbered with. Furthermore, German firms’ self-financing rate (the ratio of savings to fixed capital) essentially exceeds 100%, explaining why there is a faster rate of productive investment in Germany. Meanwhile, the greater capacity for investment in Germany will be amplified if it becomes more difficult to obtain credit, which is likely to be the case in France due to the impact of new prudential rules for banks.

Causes of low corporate profitability in France

There are two major causes for French companies’ poorer profitability:

1. Less sophisticated industrial products

The fact that French industrial companies are unable to pass increases in production costs on to consumers shows their weak pricing power and the low level of product sophistication. Demand for French products is therefore price sensitive, which is not the case for German products, and explains why France’s export market share fell when the euro appreciated between 2002 and 2008 yet Germany’s did not. Meanwhile, it could also be said that France is stuck in a vicious circle: the low product sophistication of French companies reduces their profitability, which reduces their ability to invest and enhance the quality of their products.

2. The nature of labour market negotiations

The rise in unemployment and the weakness of activity has caused a significant slowdown in wage growth in Germany. However, this has not occurred in France, where wages have been less sensitive to the performance of the economy. Since wage costs remain high, it is more difficult for French companies to enhance corporate profitability after periods of weak growth.

Indeed, profitability remained low in France from 2003 to 2007 and from 2010 to 2012, yet improved in Germany. So labour market negotiations in France seem to favour "insiders" (employees who have kept their jobs) instead of encouraging firms to hire new staff. But in Germany it is easier to negotiate the wages of existing employees and therefore to recruit new staff.

Which economic policy approaches should be used in France in order to address these issues?

Government policy should seek to boost corporate profitability by:

  • Lowering labour costs to restore profit margins for French companies and to boost investment. This can be achieved through tax reforms that reduce the weight of welfare contributions;
  • Helping French companies to invest more despite their low self-financing rate. This could include government intervention such as public-sector funding or loans via state-owned banks, as well as through the development of a large corporate bond market;
  • Helping companies to improve product sophistication through government research grants, government contracts for technological products, and offering support for new industries: digital, energy, etc.;
  • And finally, by changing the nature of negotiations between unions and employers in France to ensure the employment component is taken into account in negotiations.
Patrick Artus

A graduate of Ecole Polytechnique, of Ecole Nationale de la Statistique et de l'Adminstration Economique and of Institut d'Etudes Politiques de Paris, Patrick Artus is today the Chief Economist at Natixis. He began his career in 1975 where his work included economic forecasting and modelisation. He then worked at the Economics Department of the OECD (1980), before becoming Head of Research at the ENSAE. Thereafter, Patrick taught seminars on research at Paris Dauphine (1982) and was Professor at a number of Universities (including Dauphine, ENSAE, Centre des Hautes Etudes de l'Armement, Ecole Nationale des Ponts et Chaussées and HEC Lausanne).

Patrick is now Professor of Economics at University Paris I Panthéon-Sorbonne. He combines these responsibilities with his research work at Natixis. Patrick was awarded "Best Economist of the year 1996" by the "Nouvel Economiste", and today is a member of the council of economic advisors to the French Prime Minister. He is also a board member at Total and Ipsos.

Website: cib.natixis.com/research/economic.aspx

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