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France, Germany, and Italy press ahead to spur their economies

Summary:
The COVID-19 pandemic compelled the G7 advanced industrial democracies to take drastic action to buttress their economies earlier in 2020, focusing on job retention and business loan guarantee programs. More than six months later, however, only France, Germany, and Italy have launched or are moving toward a second round of recovery plans. The other four G7 economies (Canada, Japan, the United Kingdom, and the United States) are still focused on crisis response, though many initial measures have been extended, particularly with regard to job retention schemes. Why the variance? Many explanations apply. First, the three major continental European governments share a preexisting appetite for government involvement in their economies, far greater than their G7 counterparts. Government

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The COVID-19 pandemic compelled the G7 advanced industrial democracies to take drastic action to buttress their economies earlier in 2020, focusing on job retention and business loan guarantee programs. More than six months later, however, only France, Germany, and Italy have launched or are moving toward a second round of recovery plans. The other four G7 economies (Canada, Japan, the United Kingdom, and the United States) are still focused on crisis response, though many initial measures have been extended, particularly with regard to job retention schemes.

Why the variance? Many explanations apply. First, the three major continental European governments share a preexisting appetite for government involvement in their economies, far greater than their G7 counterparts. Government expenditure to GDP in France was 56 percent of GDP in 2019, while it was 39 percent of GDP in Japan, the United Kingdom, and the United States. In the United States and the United Kingdom, if not elsewhere, a significant backlash has developed over further government spending and future debt burdens. Equally significant, France, Germany, and Italy are more willing to use the COVID-19 response to support industrial policies, with a particular emphasis on transitioning their economies to low-carbon models to deal with climate change.

France announced its COVID-19 recovery plan in early September. The plan shares several features with the recovery plan of Germany, which was announced three months earlier. Italy’s plan is expected later in September. The plans announced so far demonstrate a shared vision for overcoming the crisis. The focus on green investment may be a useful example for other G7 countries, who are yet to announce a recovery plan.

Both the German and French packages focus on investment in green technology, more support for workers and firms, and industrial policies

There are five notable common features in the French and German recovery plans. First, the size of the proposed package of measures is similar between the two countries (in France €100 billion, or 3.7 percent of GDP; in Germany €130 billion, or 3.8 percent of GDP). The German package may actually be smaller in relative size once properly calculated. In particular, the tax deferrals to businesses were already budgeted in April, while fiscal transfers to local authorities would automatically happen in France and should be netted out.

Second, both governments focus on investment in green technologies and use these investments to headline their recovery plans. Nearly a third of the French package (€28 billion) is investment in green transformation. About a quarter of the German plan is investment in green transformation (€24 billion). The measures are identical: development of the hydrogen sector, railway network investments, subsidized purchases of electric vehicles, R&D financing for the car industry, and thermal renovation of buildings.

Third, both countries further expand assistance to workers. Facing a larger projected economic decline in 2020 (10 versus 6.5 percent in Germany), France is spending €19 billion on job retention, vocational training, and education for workers in hard-hit industries. New short-term measures preserve employment and ensure that young people who are entering the labor market can work in the coming months. These measures include the extension of partial employment assistance; hiring bonuses for young workers and the disabled; and support for employers of apprentices and conversion of apprentice contracts to long-term contracts. Another set of measures finances training for workers who wish to change sectors. Germany is investing in digital technologies (€15 billion) to connect more people to jobs remotely and ease the administrative burden on businesses. Alongside this new digital outreach, the German government announced a further extension of the earlier job retention program.  

Fourth, support for businesses is being expanded with tax measures and liquidity support. The reduction in output taxes in France (€20 billion) gives companies, especially those not turning in profits, some breathing room in terms of liquidity. The French government is further increasing liquidity provision to companies through state-guaranteed loans or equity. These schemes go beyond the assistance provided in the loan guarantee programs announced during the early crisis response period. Germany’s new package for businesses is worth €21 billion. Business support schemes are envisioned in terms of boosting cash balances through deferral of value added tax (VAT) on imports and more flexible depreciation rules. Larger state contributions to employees’ social security add another €5 billion to the recovery package.

Fifth, linked to these economywide measures are proposals that mark a return of industrial policy, exemplified in the support for the hydrogen and car sectors. This feature was already apparent in individual bailout packages by the two governments, for example, for Renault in France and Lufthansa in Germany. France makes it explicit in its recovery plan by budgeting €1 billion for reshoring of strategic industries.

An additional element of the German recovery plan is a €39 billion demand boost, which features a temporary VAT cut, estimated to leave €20 billion in the hands of consumers. Other elements include a reduction in household electricity prices, a one-time €300 bonus payment for children, an increase in the single parent allowance and further subsidies for childcare and daycare. A comparable component is missing in the French recovery plan, which instead relies on a mixture of supply- and demand-enhancing measures.

But both lack contingency plans and do not address restructuring corporate debt

Two notable omissions are apparent in the French and German recovery plans. First, both plans do not tackle the issue of restructuring corporate debt. Such restructuring will be inevitable, and the current insolvency systems in France and Germany may be overwhelmed by a large number of cases once the temporary freeze on bankruptcy cases is lifted in December 2020 and March 2021, respectively. The insolvency law needs to be improved and  procedures simplified to make it easier for companies to be reorganized. The two governments may need to cancel some deferred corporate taxes and use this cancelation as leverage with commercial banks to roll over and perhaps reduce debt.

Second, neither country offers a contingency plan, in case the economy fails to rebound. The German plan to some extent anticipates such a possibility with the temporary reduction of VAT rates. This reduction can be extended in case the economy does not pick up sufficiently. The French government is contemplating some ideas to help demand, but these are not spelled out in the September package.

A follow-up recovery package early next year is the logical place to address the debt restructuring issue and offer contingency options.

Simeon Djankov
Simeon Djankov, nonresident senior fellow at the Peterson Institute for International Economics, was deputy prime minister and minister of finance of Bulgaria from 2009 to 2013. In this capacity, he represented his country at the Ecofin meetings of finance ministers in Brussels. Prior to his cabinet appointment, Djankov was chief economist of the finance and private sector vice presidency of the World Bank.

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