Demand is infinite, supply is limited. In its simplest form, this is the fundamental economic problem. In a way, an economy’s growth rate represents how fast its participants are solving the economic problem.
Properly enacted economic policy is critical for a well-functioning economy and a high growth rate. While the promise by a credible central bank to supply liquidity in times of crisis can end a panic, and a well-timed fiscal policy can smooth the economic cycle, such policies do little more than shift demand around over time. Neither policy can permanently raise an economy’s long-run speed limit in a major way.
On the other hand, properly set rules and regulations that govern, among other things, labour markets and the productions of goods and services can dramatically improve an economy’s long-run prospects. In their most basic form, these include property rights, credible courts to settle disputes, and the rule of law. Because we in the Western world take these most basic rights as given, we can neglect the nuanced way in which negative regulations can accumulate over time to such an extent that they begin to have large economic consequences.
Once in a while, however, when a major country does address these issues, the effects are usually dramatic. In the 1970s, the UK seemed to be the unreformable country, scarred by the shock of having lost an empire and unable to shake off the yoke of particularly bolshie trade unions. Then came Margaret Thatcher.
After 1994, Germany seemed to be blighted by a permanent ‘Reformstau’, partly unable and partly unwilling to change because its federal structure decentralises power to such an extent that a turnaround would be impossible. The two separate houses of parliament with their different majorities always seemed to block each other. Then came Gerhard Schröder, who struck a deal with then-opposition leader Angela Merkel to get serious reforms through both houses of parliament.
By critically analysing the rules governing their labour markets, and removing the excess regulation that had crept in slowly over time, Thatcher’s Britain and Schröder’s Germany both turned from their sick man of Europe status into its economic powerhouses.
Today, the major supply-side reformer in Europe is France. Last September, French President Emmanuel Macron introduced sweeping labour market reforms that will liberate France’s sclerotic labour market over time. Within a few years, France should enjoy an unemployment rate that is heading towards the sub-5% British and German rate from its current 8.9%.
Thanks to Macron’s labour market and tax reforms, France is on track to become Europe’s economic powerhouse in the next decade, outclassing a Germany that looks set to undo some of its good work in the coming years, and a UK that seems intent on shooting itself in the foot by leaving its major market, the EU. With its high birth rate, France could even achieve a trend rate of growth beyond Germany and the UK in the coming years.
Kallum Pickering is senior UK economist at Berenberg Bank. The opinions expressed are his own.