Germany and France face severe industrial unrest. But while this may cause short-term disruption it could have the longer-term benefit of encouraging the governments to deal with underlying structural problems
The two biggest economies in Europe, Germany and France, face a summer of severe industrial unrest as trade unions take to the streets. They will be protesting against the wide ranging pension and labour market reforms their respective governments are attempting to introduce.
In the short term, the effect on European economic growth will be negative as industrial production is disrupted by the strikes. Growth in Europe is already under pressure from the global economic slowdown and the stronger euro, which is hitting export volumes. Euroland GDP growth is forecast to be only 1% for 2003 and the first quarter figures reported this week show Germany is hovering on the brink of recession.
In the short term, the strike activity by the unions will be disruptive. However, in the long run, if these planned reforms are implemented they could revolutionise how firms operate in these economies, boost the long-term trend GDP growth of Europe and change the perception investors have of Europe.
Also at stake are the political careers of Jacques Chirac and Gerhard Schroder. They need to show whether they possess the determination and political party support to finally successfully challenge the domination of trade unions in the labour market.
The French government must seize the initiative and use current popularity gained from its anti-war stance to introduce much needed state pension reforms. Finance minister Raffarin is proposing to realign the public sector pension system with that adopted by the private sector. The public pension scheme currently provides very generous benefits.
The proposals are twofold: there will be a progressive lengthening in the contribution period necessary to qualify for a full pension from 37.5 to 40 years and the contributions payable by the employee will increase as a percentage of salary to 10.35% from the current 7.85%.
Simultaneously, the plan is to introduce voluntary top-up pensions for both the public and private sectors of the economy and generally simplify the pension system.
The intention of proposed reforms is to reduce the public budget deficit. France, like many other European countries, has a deficit that exceeds the EU's stability and growth pact limit of 3% of GDP. For three year's running it has breached the upper limit and is in danger of receiving heavy fines from the European Monetary Union (Emu).
The proposed reforms, combined with a commitment to freeze public spending in real terms and to restructure and reduce employment in the civil service, will enable France to avoid being sanctioned by the Emu for breaching the upper limit.
The success of these changes is also critical because they are a pre-cursor to more widespread structural reforms, planned over the medium term, to introduce greater flexibility into the labour force
Two general strikes in May have caused massive disruption throughout France. The trade unions are active in key parts of the economy ' air transport, railways, education and government. Raffarin will tread carefully and it may be necessary to call a referendum to force the reforms through.
In Germany, even more radical social and economic reforms are necessary to remove the economy from the slump. Archaic employment and tax rules introduce rigidity into the labour market and discourage the hiring of workers.
Although the weak global economic cycle explains some of Germany's current malaise, it has in reality struggled since the unification boom at the beginning of the 1990s. Job creation in the past 10 years has averaged 0.25% per year against a European average of 1.25%.
As a consequence economic growth in Germany has been lower than the European average. One of the fundamental problems is the overall cost of labour in Germany, including social contributions, are just too high. The entry of Eastern European countries (with their cheap labour force) into the ERM in the next few years will make the problem worse.
This lack of job creation and prospective demographic trends will begin to place a huge burden on the funding of pensions and therefore on the budget deficit.
Chancellor Schroder's proposed reforms are ambitious and far reaching. They include reducing the generous unemployment benefits (to limit unemployment benefit to 12 months), easing firing restrictions for smaller companies and developing the possibility for companies to deviate from industry wide wages in agreement with their employees.
Schroder faces formidable resistance to the reforms not only from the trade unions but also from within his own party. His plans could also be blocked by the opposition CDU party, who hold a substantial majority of seats in the Bundesrat (the upper house) and could veto the proposals. He has threatened to resign if the reforms are not passed and therefore Germany is in danger of needing to call a general election in the next few months.
Unfortunately, there is little evidence in either France or Germany of any desire among the population for radical reforms. However, the success of these reforms are critical to the improvement of job creation in Europe, bolstering the long-term economic trend growth in Europe and to easing some of the burden of the budget deficits.
Economic growth will be negatively affected by industrial action over the summer.
The longer term effect of the strikes should be more positive leading to reduced budget deficits and increased growth.
Reform to pension regimes are a precursor to more fundamental changes to flexibility of the labour market.
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