CHALLENGES FOR FRANCE IN THE EMERGING INTERNATIONAL ENVIRONMENT: A DYNAMIC ANALYSIS

1. INTRODUCTION France has recently been beset with economic headwinds on many fronts as it tries to restructure its economy. The hallmark of the international economic scene has recently been one of change, with substantial newly emerging economies, the implementation of the European Monetary Union (EMU), the expansion of the European Union (EU), and the advent of other trading blocs. As a result of these events, the economies of individual countries are becoming much more intertwined with and challenged by international markets than in previous years. However, the available economic policy alternatives for an individual country in the EMU are more restricted than prior to the formation of the EMU. For example, the press has recently reported widespread concerns that France and Germany are not complying with and may not be able in the near future to meet EMU economic stabilization requirements. As a result, these countries are putting pressure on the organization to relax the rules of the stability and growth pact, actions that have resulted in frustration on the part of other European countries, particularly smaller ones, that have made spending cuts to bring their budgets in compliance. In addition, domestic pressures have erupted as France attempts economic reforms. (1) The current budgetary difficulties of both France and Germany are ironic in that these nations were initially among those most insistent on fiscal discipline. While both countries are making efforts at economic reform, domestic resistance to these efforts has been extensive, especially in France. Yet, if these countries are to accomplish their expressed goals of economic stability and growth, it is essential that both France and Germany succeed in implementing reforms that will make their economies more efficient and sensitive to these emerging international market forces. In this article, we concentrate on the French economy and examine elasticity of input demand estimates to see if there is evidence consistent with progress to a structure characterized by greater international market responsiveness. We then examine the implications of these findings for the French economy in the new international environment. This study uses the technology of an aggregate dynamic translog cost function with inputs of capital, labor, and imports to explore the likely impact of this continuing international integration on the French economy. (2) The use of a dynamic translog function and quarterly data, rather than a static model and annual data, allows one to estimate both short- and long-run direct price elasticities of input demand as well as cross-price elasticities for each input pair. Although a static model is simpler, some scholars have criticized the limitations of that model because it implies adjustment to equilibrium values during each time period covered by a data point. (3) II. A DYNAMIC AGGREGATE TRANSLOG COST FUNCTION An aggregate production possibility frontier for the case of one output, Y, and three inputs (labor, capital, and imports) can be expressed in the following form: (1) F(Y, [X.sub.K], [X.sub.L], [X.sub.M], T) = 0, where Y is the aggregate output of goods and services, [X.sub.K] is capital, [X.sub.L] is labor, and [X.sub.M] is imports and T represents time-related components, including technological change. (4) If the transformation function has a strictly convex input structure then there exists a unique cost function, (2) TC = [Florin](Y, [P.sub.K], [P.sub.L], [P.sub.M], T), where [P.sub.K] is the price of capital, [P.sub.L] is the price of labor, and [P.sub.M] is the price of imports. (5) The exact cost function (2) can be approximated with the familiar static translog cost function: [MATHEMATICAL EXPRESSION NOT REPRODUCIBLE IN ASCII] (3) where i, j = K, L, and M (Berndt and Christensen, 1973a, 1973b; Christensen, Jorgenson, and Lau, 1973; Guilkey, Lovell, and Sickles, 1983, p. …