In September 1992 during the European Monetary System crisis, the Spanish Peseta was devalued by 32% vis-a-vis the Deutsch-mark while the French Franc’s exchange rate remained stable. This situation was the source of tensions between French and Spanish producers. The increased competitiveness of Spanish products was a source of fragility in France, mainly in the south.
Last Thursday I was at a dinner in the south of France, in Narbonne with business leaders and the recrimination was the same. Due to reforms in Spain, Unit Labor Costs’ indices (ULC) do not have the same profile on each side of the Pyrenees. We can notice this point on the chart, below. In Spain at the end of 2013, the index is 17% lower than it was in the first half of 2008. In France, it is just 2.5% lower than more than 5 years ago. (All these measures are corrected for inflation). The divergence is striking and the change in competitiveness conditions can clearly be perceived.
What has happened after the Peseta’s devaluation?
After its accession to the European Union, Spain experienced a period of high inflation. The country was on a catch-up trajectory and its inflation rate was higher than that of France. The devaluation has not changed the process and as it can be seen on the chart below, the Spanish inflation rate remained higher than that of France for an extended period.
One immediate consequence is that the Spanish advantage has progressively disappeared. The cost advantage in 1992 was reduced by higher inflation. The long-term impact of the devaluation has been limited.
For the current situation, such an adjustment is unthinkable. The Spanish competitive advantage will not be eroded by higher inflation. The internal devaluation is pushing costs downward and is not a source for a higher inflation rate. At this precise moment, Spain is more a candidate for deflation than for higher inflation. The Spanish competitive advantage is here to stay. 1992 and its aftermath is not the good model to analyze the current situation.
What is seen with Spain can also be perceived with other Euro countries.
The interesting point here is that competition for French products is coming from the Euro Area. France has lost competitiveness and the answer can only come from France itself.
At the same time, Euro is perceived as a strong currency and we make the hypothesis that this will be true in the foreseeable future (see here).
In other words, France is facing a new type of competition within the Euro Area but also outside the Euro Area with a strong currency. This is a real break for France. Competition will be harder on the French territory and it will not be easy to export.
At different episodes of the past, the French competitiveness was eventually improved by devaluation. This adjustment mode is no longer available. France will have to change its growth process, it is probably too costly, and France will have to think about its way to do business, to have a more endogenous growth and to create jobs.
The model that has been created after World War II is probably behind us, a new one has to be created just to continue to be an important economy in Europe. France will not escape from structural reforms