Delivering a Franco-German Bouquet of Irony

The Wall Street Journal

By ALEN MATTICH

This week's Franco-German deal to save the euro is a collection of ironies, not least that it's likely to precipitate an early withdrawal from the single currency by some of its beleaguered member states.

French President Nicolas Sarkozy and German Chancellor Angela Merkel drew up a plan to fix the euro zone's problems by making sure member countries stick to sound fiscal policies. And by sound they mean budget deficits of no more than 3% of gross domestic product, with the aim they balance their budgets over the economic cycle, and gross-debt-to-GDP ratios of below 60%.

And along the way, tax and economic policy is to be coordinated and member states must improve their competitiveness.

They also suggested sanctions in case of failure. Offending countries would be punished by having their payments from the European Union's cohesion fund withheld. These funds act as relatively modest fiscal transfers from the EU's richer regions to its poorer ones.

But though modest in terms of the EU's overall GDP, the fund is a big slice of its spending. It's worth €347 billion ($496 billion) for the five years to 2013, or more than a third of the EU's overall budget. It's also not inconsiderable for Europe's poorest countries. For example, Greece's share is worth about 1.8% of its GDP over the period.

Hitting countries that already can't balance their budgets by withdrawing further funds just compounds an already big problem.

And, of course, it also ignores a big irony. The euro zone's 3%/60% rule is nothing new. It was embedded in the Maastricht Treaty obligations that laid the ground for the single currency. And France and Germany have been two of its biggest transgressors. Germany's annual deficit was more than 3% from 2002 to 2005, inclusive, while France's was above that level from 2002 to 2004. Germany's gross-debt-to-GDP ratio has been above 60% since 2002 and France's since 2003.

Arguably, the heart of the euro zone's problem isn't a matter of culture or governance or remaining barriers to trade in goods. Rather, it's the huge hurdle that has always existed: Europe's multiplicity of languages. The fact that few Greeks or Portuguese have enough German to take on professional or even semi-skilled jobs in Germany removes the sort of safety valve that properly integrated federations rely on.

A case in point is the Texan economic miracle, the subject of considerable debate in the U.S. right now. Texan politicians make strong claims for the state's performance relative to the rest of the U.S. during the recovery. Doubters point to the fact that Texan unemployment remains high.

But a close reading of the data by Matthias Shapiro on his Political Math blog highlights something very interesting. Texan unemployment belies the strength of the state's economy because it has had considerable population growth during the past couple of years. Texas's strong employment growth has inspired people to flock to the state—so much so that the actual proportion out of work hasn't come down as fast as it might have done otherwise.

Since the start of the recession in December 2007, Texas's labor force has grown by 6%, astonishingly quickly for such a large state—more than twice as fast as the next-fastest state. When people are hit by hard economic times in one part of the U.S., they pack their bags and move to where the jobs are. The same doesn't happen in Europe.

For instance, the economically active population in Germany, Europe's economic powerhouse, has shrunk by about half a percentage point during the same time Texas has boomed. This is why Germany's unemployment rate has fallen much faster than that of Texas even as unemployment remains at stratospheric levels in countries like Spain.

Even in the years before the financial crisis, immigration to Germany from other European Union countries was equivalent to only about 0.4% of Germany's population, and most of that in the form of cheap labor from neighboring Poland.

Because it's harder for people from poorer euro-zone countries to move to the core, where there are jobs, fiscal transfers are crucial to address imbalances between the economies. But there's currently very little scope for these in Europe. EU spending as a percentage of GDP is less than a tenth of the U.S. federal government's.

One way to mitigate the lack of direct fiscal transfers would be to introduce common euro-zone bonds as a means of cutting the peripheral countries' interest costs. But although Germany has edged back from its blanket refusal to countenance them under any circumstance, France's Mr. Sarkozy said fiscal integration needed to happen first.

Would Germany subscribe to euro-zone bonds even then? The market is hinting at the price of Germany's commitment to Europe. The cost of insuring its debt with credit-default swaps has risen sharply during the past month-and-a-half, to the point where five-year U.K. CDS are now cheaper than equivalent German ones. Although flight-to-safety trades have supported demand for German bonds, the CDS market suggests that might not last long if Germany were to commit to backstopping a common euro-zone bond.

There's a further irony in Franco-German demands that all countries in the bloc boost their competitiveness. One of the major imbalances in the single currency is the lack of competitiveness of peripheral countries relative to the core. Unless the core is willing to lose ground here, the region is at an impasse. Saying every country in the euro zone should become more competitive is like saying every child in Lake Wobegon is above-average. A nice idea but it defies the math.

Instead, what the Franco-German deal seems to have created is the circumstance under which peripheral countries will be forced out of the single currency. Then again, things were probably heading in that direction anyway.

Write to Alen Mattich at alen.mattich@dowjones.com