France and Germany propose 'hair-shirt union'

The two states will unveil the broad outlines of the plan, which proposes harmonisation of corporate taxation and labour policies, over lunch at Friday's European summit in Brussels.

In what would be an unprecedented move towards common European spending decisions and labour markets under strict fiscal discipline, the "Competitiveness pact" as it has been named by its architects, will also seek to eliminate inflation-indexed wage agreements and move toward a common EU retirement age of 67.

The latter demand comes hot on the heels of a fearsome battle Paris waged against trade unions and young people last year over an increase in the retirement age from 60 to 62.

Countries would also be forced to amend their constitutions to forbid public deficits exceeding a certain percentage of GDP, similar to Germany's "debt break," which limits any new borrowing to 0.35 percent of GDP from 2016.

Should other member states agree to such exacting concessions, Germany now appears willing to agree to demands by other member states to boost the effective lending capacity of the €440 billion eurozone bailout fund and to allow the European Financial Stability Facility to expand its remit.

As part of the grand bargain, France said on Wednesday that it will introduce its own debt break, a constitutional balanced budget amendment Paris is describing as a "golden rule." Proposals along these lines will be presented domestically in the coming weeks.

Technical details of the Berlin-Paris concord will only be shown to the rest of the union next month.

"It is at the March summit that we will propose what we call the 'global package', which includes a certain number of elements including reinforced competitiveness and a better convergence of economic policies,"French finance minister Christine Lagarde told reporters on Thursday.

German Chancellor Angela Merkel flew to Madrid on Thursday to discuss the pact with Spanish Prime Minister Jose Luis Rodríguez Zapatero.

Upon arrival, she told Spain that its current austerity measures were insufficient and that she wanted, for example, to see wage indexing eliminated.

Nicolas Sarkozy has also proposed that the heads of the 17 states that use the single currency hold an annual eurozone summit to co-ordinate and assess the state of economic convergence. The pact targets eurozone members and is optional for those such as Sweden or the UK that retain a national currency.

UK sources on Thursday said they were not worried about being isolated from a hardcore of European states and were "quite relaxed about it."

"The eurozone can do what it wants to do. Decisions that affect the 27 would still be taken by the Ecofin Council [all 27 finance ministers]," a British official sai. "It should be remembered that there is quite a lot of Europe outside the Eurozone, not just the UK."

Market watchers however were sceptical that France and Germany could convince the rest of the bloc to go along with the pact.

"It's a distraction that's going to have very little chance of success in terms of agreement to implement it," one contact told EUobserver. "It's designed primarily for the consumption of the domestic German electorate, to move the focus away from the EFSF and German tax liability, but must be rightly seen by everyone else as a grand, ambitious set of headline proposals that ultimately won't go anywhere."

"With its very tough, sovereignty-eroding measures, it's very likely to be opposed by many member states," the source continued, although he believed that though much of the pact would be rejected, what would remain would be that countries that are bailed out would have to adopt constitutional balanced-budget amendments.

"What it will probably boil down to is that the quid pro quo for future access to bail-out funds is this constitutional change."

He described the move towards fiscal union as more akin to a "hair-shirt union", saying it was inappropriate to impose the German model on the rest of the eurozone. "After the disaster of the Stability and Growth Pact, this is more of the same thing multiplied, but anything multiplied by zero is still zero."