Different Trains: Germany and France GDP

The preliminary estimates of 3Q GDP showed both France and Germany growing +0.2% qoq. This was as expected for Germany, but a pleasant surprise for France (though one that risks being revised away at a later date). It paints a comforting picture of enduring convergence between the Eurozone's two largest economies. 

Unfortunately, the likelihood that France and Germany will continue to grow at a similar pace in coming years is an illusion. The problem is not so much to do with the financial problems of the Eurozone per se, but rather that the two countries grow in different ways. Whilst for the first decade of the Eurozone this was masked by historic coincidence, it is unlikely to be so in the next decade. France must expect a long retreat in its GDP relative to Germany.

And this would be new. Between 2000 and 2007, German growth averaged 1.7% a year, whilst France average 2.1% in real terms, suggesting a compatibility that tilted slightly in France’s favour. In real terms, since 2000, France's GDP has grown by 30%, Germany's by 25%. In nominal terms, however, the difference has been tilted sharply to France: it has growth 68% since 2000, whilst Germany has grown only 36%. The advantage of the single currency, then, would seem to have been primarily France's.

This state of affairs, however, is now unravelling, because Germany was pursuing a growth model based on relatively low growth in capital stock but high and rising rates of return on that capital, whilst France’s growth was secured by high growth in capital stock but a far lower, and falling, rate of return.

We can see this by estimating growth of capital stock by depreciating all investment over a ten year period, and then expressing GDP as an income from that stock of capital. Of course, this is an imperfect measure, but it is at least likely to indicate broad differences between growth models, as well as changes in direction of ROC.

First, between 2005 to now growth of Germany’s capital stock averaged 1.1% pa, whilst France’s was leaping along at 4.5% pa. As the chart below shows, the mismatch in growth of capital stock has diminished over time, and particularly during the last couple of years.

However, the corollary is that whilst Germany's economy was winning rising asset turns, and rising ROC from its capital stock,in France the extra investment was producing sharply diminishing asset turns. Again, the most noticeable divorce in trends took place before the onset of the financial crisis. However, Germany's legacy is that it now seemingly enjoys sharply higher ROC than France.

Until the outbreak of the financial crisis, this difference in economic models was not recognized in any significant bond yield differential: France could finance its high-investment/low return growth model on the same terms as Germany's low-investment/high return growth model. But those days are over: currently 10yr German government bonds yield 1.42% whilst France's yield 2.15%. If France continues to pursue its traditional high investment/low returns model, whilst Germany persists in the opposite model, there is no reason to expect bond yields to converge again. 

Indeed, the gap in relative investment behaviours is already narrowing fast: in 2008 at the beginning of the crisis, France’s capital stock was growing at 6.9% yoy, whilst Germany’s lagged at 2.1%. In the year to 3Q, I estimate France’s growth of capital stock had slowed to 3%, whilst Germany’s had risen slightly, to 2.4%. But there has been little change in either country's return on that capital as expressed in nominal GDP.

These numbers are the very cornerstone of future growth: unless they change again, they guarantee that the years when France’s nominal GDP outpaced Germany's are over. Indeed, the long retreat has already begun: when the Euro was introduced in 1999, France's nominal GDP was 67.5% that of Germany: that proportion rose almost uninterrupted to a peak of 79.6% in 3Q2009. Three years later it had fallen back to 76.8%, and there is no reason to think its retreat will not be as steady as its rise.