Economic Governance divides France and Germany

The move stunned France and showed how the euro zone's two largest economies are struggling to coordinate policy during the debt crisis that has engulfed the single currency.

"France and Germany will have to start speaking the same language or else the euro will disintegrate," said Alexander Law, chief economist at Xerfi consultancy in Paris.

French President Nicolas Sarkozy has said repeatedly since the start of the Greek debt disaster that euro zone countries must now establish common economic standards and practices if they want their currency to flourish.

But the very concept has revealed core differences between Paris and Berlin, with France talking of "economic government," which sends a shiver down German spines, and Berlin preferring to talk about "economic governance."

The word "government" gives the impression of an outside body that would dictate economic policy, whereas governance raises the prospect in German minds of creating structures, framework and sanctions.

"We are coming from very different directions," said Ulrike Guerot, senior research fellow at the European Council on Foreign Relations (ECFR) and head of its Berlin office.

"If you come from very different poles, you are bound to bang up against each other. But hopefully there will be a very constructive discourse," she added.

CORE ECONOMIC CONTRADICTIONS

At the heart of the problem are core contradictions between France and Germany over economic development, with no easy solutions in sight.

Germany has undergone painful reforms to create a lean, efficient export machine that is creating unsustainable imbalances across the euro zone.

While Germany is ratcheting up seemingly endless trade surpluses, many of its neighbors, including France, are building up multi-billion euro deficits.

For Paris the answer is obvious -- Germany should boost domestic demand and cut taxes to encourage imports. For Berlin, the answer lies outside its borders -- other countries should simply copy it, primarily by lowering wages.

French officials mutter in private that Germany, which does not have a minimum wage, is simply salary dumping. Germans say it is this solid economic management that they are proud of.

A NECESSARY EVIL, OR JUST EVIL?

Other major battles lie ahead as the euro zone struggles to recover from last year's brutal recession while trying to keep the lid on deficit and debt-levels.

One senior adviser to Sarkozy, Henri Guaino, has argued that the euro zone could benefit from a spell of controlled inflation to relieve the pressure, to the dismay of Germans.

"The French say, 'what is so wrong with inflation of four percent?'. It will be competitive inflation. But for the Germans, inflation at four percent is evil," said Guerot.

France thought that it had won the opening rounds of the battle to create a more homogenous economic management when German Chancellor Angela Merkel finally agreed this month to a $1 trillion rescue package to stabilize the currency.

French officials purred that Germany finally realized what was at stake and was ready to bend to the demands of its partners and resolve long-standing EU economic tensions.

A triumphant Sarkozy gave a news conference in Brussels in front of the 16 flags of the euro zone nations, rather than just the simple EU standard, to herald the improvement in coordination. The German press painted him as the victor.

"Sarkozy, the new king of Europe," said the Berliner Zeitung newspaper in a headline, adding that economic governance or even government was now looking inevitable.

"The Germans would have none of that in the past," the paper wrote. "The German taxman has failed. From here on in the French take the helm."

GERMAN CLOUT

Germany's announcement to ban naked short sales of a range of assets wrong-footed many of its European partners who had hoped that the coordinated action on the rescue package would have taught Berlin not to go it alone.

"Germany took this decision for pure German reasons related to the economic and political situation in Germany," said Jean-Pierre Jouyet, the head of French financial markets regulator AMF who is seen as close to Sarkozy.

In unusually frank language, he told Reuters that such unilateral moves could damage the euro.

"(The euro) will not be in danger as long as there is an orderly governance and therefore any confusion will help more to weaken the euro than to strengthen it," he said.

However, France and its southern Mediterranean neighbors, which are all struggling to contain their deficits, face an uncomfortable truth -- Germany is the richest country in the bloc, carries more weight then any of them and won't be cowed.

So when it comes to thrashing out a new-look economic governance in Europe, Germany will make this clout felt.

"I think that France will end up agreeing with everything Germany says, because they have to, but then they will simply continue to flout the rules as they have done in the past," said Xerfi's Alexander Law.