Convergence or Divergence in Europe? Growth and Business Cycles in France, Germany and Italy

Convergence or Divergence in Europe? Growth and Business Cycles in France, Germany and Italy

Olivier de Bandt Heinz Herrmann Giuseppe Parigi Convergence or Divergence in Europe? Growth and Business Cycles in France, Germany and Italy With 116 Figures and 80 Tables 12

Olivier de Bandt 46-1405 DGEI-DAMEP Banque de France 39 rue Croix des Petits Champs 75049 Paris, France olivier.debandt@banque-france.fr Heinz Herrmann Forschungszentrum Deutsche Bundesbank Wilhelm Epsteinstraûe 14 60431 Frankfurt/Main, Germany heinz.herrmann@bundesbank.de Giuseppe Parigi Servizio Studi Amministrazione Centrale Banca d'italia Via Nazionale 91 00184 Roma, Italia giuseppe.parigi@bancaditalia.it ISBN-10 ISBN-13 3-540-32610-3 Springer Berlin Heidelberg New York 978-3-540-32610-6 Springer Berlin Heidelberg New York Cataloging-in-Publication Data Library of Congress Control Number: 2006929199 This work is subject to copyright. All rights are reserved, whether the whole or part of the material is concerned, specifically the rights of translation, reprinting, reuse of illustrations, recitation, broadcasting, reproduction on microfilm or in any other way, and storage in data banks. Duplication of this publication or parts thereof is permitted only under the provisions of the German Copyright Law of September 9, 1965, in its current version, and permission for use must always be obtained from Springer-Verlag. Violations are liable for prosecution under the German Copyright Law. Springer is a part of Springer Science+Business Media springeronline.com Springer Berlin Heidelberg 2006 Printed in Germany The use of general descriptive names, registered names, trademarks, etc. in this publication does not imply, even in the absence of a specific statement, that such names are exempt from the relevant protective laws and regulations and therefore free for general use. SPIN 11678830 Printed on acid-free paper ± 42/3100 ± 5 43210

Acknowledgements blank The articles published in this book were discussed by academics and economists from central banks or international organisations during the Conference held in Paris on 22 and 23 June 2005. The authors wish to express their sincere appreciation to them. This includes, in alphabetical order: Prof. A. Benassy-Quéré (CEPII and University Paris X-Nanterre), Prof. A. Brender (Dexia Bank and University Paris-Dauphine), G. Cette (Banque de France), P. Crowley (Suomen Panki, Helsinki), M. Diron (European Central Bank, Franfurt), E. Dubois (French Treasury), B. Enfrun (Banque de France) Prof. R. Faini (University of Rome - Tor Vergata), Prof. D. Giannone (Université Libre de Bruxelles), Prof. H. Kempf (University of Paris I- Sorbonne), B. Mojon (European Central Bank, Frankfurt), Prof. J. Pisani-Ferry (Bruegel Institute, Brussels, and University Paris-Dauphine), W. Röger (EU Commission), G. Rünstler (European Central Bank, Frankfurt), F. Sédillot (OECD), Prof. S. Schreiber (University of Frankfurt), H. Strauss (OECD), M.-O. Strauss-Kahn (Banque de France), J. Torres (Bank of Spain). In addition, special thanks to C. Cahn (Banque de France) who, on top of contributing a paper, expertly assembled the different articles in L A TEX.

Preface Against the background of the subdued recovery in the euro area and increasing disparities among member countries at the beginning of the new century, the objective of the book is to investigate the common features as well as the sources of differences in the performance of Germany, France and Italy, the three largest euro area countries, over the last 15 years. The book is a collection of papers written as part of a Joint Research Project carried out in the last two years by economists in the Bundesbank, Banque de France and Banca ditalia. Two major changes characterise the period since the last decade of the twentieth century. The first concerns the technological paradigm on which production systems are based. Here a sort of revolution is taking place. The extensive use of information and communication technologies (ICT) is radically changing all production systems in a way not very dissimilar from what the electric engine did one century ago. The benefits of ICT for an economy depend however on three key conditions: a) all firms in the economy should apply them, not only the firms in the high-tech sectors; b) the human capital should be improved and enlarged according to the needs of the new paradigm; c) firms reorganize their productive structure in order to exploit all the advantages deriving from the use of ICT. All these factors are at the root of what has been defined as the New Economy and the European economy is far behind anglo-saxon economies in the adoption of the new paradigm. The second major change is the appearance on the international markets of new and very aggressive competitors, mainly from Far East Asia. Actually, this is not a new event. In the last two centuries the same happened for the USA, Germany and Japan. The appearance of China and India on the international markets has wide-ranging effects on the industrial systems of the incumbent economies, especially for those countries which are most fragile and exposed to the international competition in mature industries. On this regard it is interesting to analyze the different reactions of the economies of

viii Preface Germany, France and Italy during a period with a common currency so that exchange rate adjustments are no longer possible. A central question is to assess the degree of comovement of the French, German and Italian economies or the lack thereof at particular occasions. Are they extraordinaryevents vis à vis a long term trend favouring convergence, or can we detect changes in the last few years? The book endeavours to provide some explanations of the movements observed in the last years: in view of the major changes described above can they be ascribed to potential growth dynamics, are they associated with external trade performance, or more generally are they linked to a different behaviour of demand components? In this respect divergences in the external positions of the three countries under consideration are remarkable and this volume tries to shed more light on this issue. A further point is to what extent the German unification is still playing a role when we compare the three economies today. A final important question is whether monetary union fosters convergence. Krugman (1993), in his work on the location of economic activities and agglomeration associated with increasing returns to scale, argued that as countries become more integrated they specialise in the production of goods and services for which they have a comparative advantage, hence they become less diversified and more subject to idiosyncratic shocks, what reduces the gains for monetary union. In response, Frankel and Rose (1998) stressed the endogeneous nature of an optimum currency area: trade integration associated with monetary union develops intra-industry trade, hence higher co-movement across the countries in the union. Empirical work has indeed shown that intra-industry trade has increased between European countries. Although the book looks mainly at possible divergence between the three countries, one should not overemphasise the differences. It becomes clear that there are also many similarities. Furthermore, one should keep in mind that in a monetary union some disparities may always exist. In particular, it has been demonstrated that the growth differentials among the 12 euro area countries - measured by the standard deviation of euro area growth rates - is of the same order of magnitude as among the 51 American states, which benefit from much more powerful risk-sharing mechanisms like the US Federal Budget. What may appear to be new, however, is the widening differences across the more mature economies in the euro area, even if, in retrospect, to some extent this already occurred in the recent past. The book is organised into six sections. An overview of the main findings of the papers is presented in Part I, recasting them in the perspective of the existing literature. The following four parts are designed to answer the questions presented above. They deal with measuring growth and cyclical asymmetries (Part II); assessing the role of supply side (Part III); studying the dynamics of demand components (Part IV); analysing the contribution of external trade (Part V).

Preface ix The assessment of the book is that there is evidence of significant correlation in the short and medium run between the countries, while more significant differences appear in the long run, in terms of potential growth. Apart from demographic factors (the insufficient growth and the ageing of the population which may affect the overall growth rate of a country as well as its capacity to fund its welfare state) this may depend as well on the structural reforms, which have not made sufficient progress during the last few years. In this respect the delay with which the different features of the New Economy are having an impact in the different economies requires particular attention. This factor is also at the origins of the disappointing evolution of Total Factor Productivity in most European countries vis à vis the US economy. These asymmetries should therefore encourage more structural reforms in both the labour and product markets in order to facilitate and speed up the process of convergence towards more modern productive systems according to the new technological paradigm. This is why central bankers support structural reforms, even if it goes beyond monetary policy. In view of these extraordinary challenges, one final question is whether the differences that are highlighted in the book (in particular higher GDP growth in France), although structural in nature, will be enduring if one projects these economies over the 15-year horizon. The better export performance of Germany, described in Part V of the book, may indicate that profound changes are currently at work. First drafts of the papers were presented in a conference held at the end of June 2005 in Paris, introduced by Marc-Olivier Strauss-Kahn, Director General of Economics and International Relations at the Banque de France. Each paper was then individually discussed by experts from academia and other central banks, notably the European Central Bank. In the same conference a panel discussion was also organised among leading European experts, such as Anton Brender of Dexia Bank, Jean Pisani-Ferry of the Bruegel Institute in Bruxelles, R. Faini of the University of Rome (Tor Vergata) and Domenico Giannone from Université Libre de Bruxelles. Their contributions are also presented in Part I of the book. The Joint Research Project was designed to reinforce convergence not only between the economies of France, Germany and Italy, but also between economists and researchers in the respective Central banks. This book may be interpreted as a sign of the success of this effort. Each national central bank contributed in each of the different parts of the book and common conclusions were jointly drafted. Nevertheless, the articles express the opinion of the authors and do not necessarily reflect the position of the Bundesbank, the Banque de France, the Banca d Italia, or the Eurosystem. OlivierdeBandt,BanquedeFrance Heinz Herrmann, Bundesbank Giuseppe Parigi, Banca ditalia

Contents Part I General Conclusions Measuring Cyclical Comovements and Asymmetries in Growth and Business Cycles Olivier de Bandt... 3 Supply-side Developments Heinz Herrmann, Jörg Döpke... 17 Cyclical Patterns in Main Components of Aggregate Demand Francesco Zollino... 27 Convergence and Divergence in External Trade Olivier de Bandt, Jean-Pierre Villetelle... 41 Panel Discussion Anton Brender, Jean Pisani-Ferry, Domenico Giannone, Riccardo Faini... 47 Part II Measuring Cycles Tracking the Economy in the Largest Euro Area Countries: a Large Datasets Approach Riccardo Cristadoro, Giovanni Veronese... 63 Assessing Aggregate Comovements in France, Germany and Italy Using a Non Stationary Factor Model of the Euro Area Olivier de Bandt, Catherine Bruneau, Alexis Flageollet... 95

xii Contents Part III Supply Side Capital, Labour and Productivity: What Role Do They Play in the Potential GDP Weakness of France, Germany and Italy? Antonio Bassanetti, Jörg Döpke, Roberto Torrini, Roberta Zizza...123 Estimating Potential Output with a Production Function for France, Germany and Italy Mustapha Baghli, Christophe Cahn,, Jean-Pierre Villetelle...161 Part IV Demand Side Synchronisation of Cycles: a Demand Side Perspective Guido Bulligan...187 Short-Run and Long-Run Comovement of GDP and Some Expenditure Aggregates in Germany, France and Italy Thomas A. Knetsch...209 Synchronization of Responses to Cyclical Demand Shocks in France, Germany and Italy: Evidence from Central Banks Macro-models Andrea Tiseno...251 Part V External Side Market Shares and Trade Specialisation of France, Germany and Italy Alberto Felettigh, Rémy Lecat, Bertrand Pluyaud, Roberto Tedeschi...291 Modelling Imports and Exports of Goods in France, Distinguishing Between Intra and Extra Euro Area Trade Bertrand Pluyaud...325 Has the Impact of Key Determinants of German Exports Changed? Kerstin Stahn...361

List of Contributors Deutsche Bundesbank: Jörg Doepke, Heinz Herrmann, Thomas Knetsch, Kerstin Stahn. Contact : Deutsche Bundesbank, Economics Department and Research Centre, Wilhelm Epstein Strasse 14, 60014 Frankfurt am Main, Germany. Banque de France: Mustapha Baghli, Olivier de Bandt, Catherine Bruneau (and Université Paris X-Nanterre), Christophe Cahn, Alexis Flageollet (and Université Paris X-Nanterre), Bertrand Pluyaud, Rémy Lecat, Jean-Pierre Villetelle. Contact : Banque de France, 46-1405 DGEI-DAMEP, 39 rue Croix des Petits Champs, 75049 Paris Cedex 01, France. Banca d Italia: Antonio Bassanetti, Guido Bulligan, Riccardo Cristadoro, Giuseppe Parigi, Alberto Felettigh, Roberto Tedeschi, Andrea Tiseno, Roberto Torrini, Giovanni Veronese, Roberta Zizza, Francesco Zollino. Contact : Banca d Italia, Servizio Studi, Via Nazionale 91, 00184 Rome, Italy.