The election of François Hollande as French president has excited
some of those who blame Germany’s emphasis on fiscal austerity for many of the eurozone’s
ills. Hollande has promised to refocus EU policies on growth and employment. Countries
such as Greece, Portugal, Spain and Italy – their recessions aggravated by the
EU’s insistence that they shrink their budget deficits – would welcome a new
approach. Even Marios Draghi and Monti, respectively president of the European
Central Bank and prime minister of Italy, and both economically conservative, have
called for growth initiatives. But can Hollande – as he prepares for his first
ever meeting with Chancellor Angela Merkel – really make a difference? He
might, but only if he handles Merkel with great diplomatic dexterity.
Many commentators have interpreted Hollande’s victory on May
6th, alongside the defeat of the established parties in Greece on
the same day, as part of a Europe-wide revolt against austerity. However,
France has not yet experienced painful austerity. And Hollande has promised to
match President Nicolas Sarkozy’s target of bringing the budget deficit down to
3 per cent of GDP next year, and also to balance the budget by 2017, a year
later than Sarkozy had promised.
Opinion polls showed that more voters trusted Sarkozy than
Hollande on economic policy, but the election was about much more than economics.
Many French people felt strong antipathy towards Sarkozy’s character and what
they considered to be his un-presidential and undignified style. He also lost
because the right is badly divided. There is a natural right-wing majority in
France – which is why in the first round of voting the right won more than half
the votes. The centre-right Gaullists always find it difficult to deal with the
far-right National Front, but this year that difficulty was compounded by
Marine Le Pen’s success in rebranding her party as more moderate than it was in
her father’s day. This enabled her to win 18 per cent in the first round of
voting. Le Pen’s refusal to endorse Sarkozy for the second round meant that
only half of her voters switched to him.
However, Hollande did campaign on a policy of ‘renegotiating’
the EU’s recently-agreed and German-driven fiscal compact – which seeks to
impose budgetary discipline – to take account of the need for jobs and growth. In
most EU capitals, including Berlin, politicians are now calling for an EU
‘growth strategy’. German officials met Hollande’s advisers before the presidential
election and told them that Merkel would not reopen the fiscal compact. But
they said that Germany could support some of Hollande’s ideas – including enlarging
the European Investment Bank’s capital base by €10 billion, targeting unspent EU
structural funds on infrastructure and introducing a financial transaction tax
(FTT). The Germans are divided on whether to back Hollande’s idea for EU
‘project bonds’ (the European Commission is already working on a scheme to boost
infrastructure investment with such bonds). But none of these initiatives would
increase economic growth significantly – and not even its advocates claim that an
FTT would create jobs.
Hollande’s prescriptions for the European Central Bank –
that its mandate should not focus only on inflation, and that it should lend
directly to governments – are unacceptable to Berlin. Another difficulty for Hollande
is that the Germans – and many others, including the two Marios – think a growth
strategy must include structural reforms that would boost productivity and thus
competitiveness, even though such reforms seldom deliver growth immediately.
Hollande appears to be as allergic to structural reform as most of his
compatriots. His election speeches called for growth to be boosted through public
spending on infrastructure and through investment in new technologies – and explicitly
ruled out deregulation and liberalisation. He seems oblivious to the fact that
France’s very high non-wage costs of employment are one cause of relatively
high unemployment (10 per cent, against 6.8 per cent in Germany).
Some of Hollande’s election rhetoric implied that he wants a
complete reversal of the EU’s austerity-based strategy for dealing with the
eurozone crisis. Many of his supporters on the French left expect him to join the
Greek leftists who denounce Greece’s bail-out package, and other so-called Keynesian
forces across the EU, to dethrone Angela Merkel from her dominance of EU policy-making.
But if Hollande tried to gang up with, say, Italy and Spain,
to force Germany into a complete U-turn, he would fail. A crude Keynesian
approach would achieve very little: some EU governments have borrowed excessively,
need to curb their deficits and cannot spend their way out of recession. Furthermore,
France has much less clout in the EU than Germany. The financial crisis and the
euro crisis have highlighted the vulnerabilities of the French economy: its
waning competitiveness means that its share of world export markets has fallen
– by 20 per cent from 2005 to 2010 – while its public debt and borrowing costs
have been rising.
This weakness meant that when the euro crisis began, Sarkozy
decided to follow the Germans on the broad lines of their eurozone strategy, but
to haggle over the details. He probably should have fought the Germans harder
over some of their proposals for the eurozone crisis. But because Germany is
the biggest contributor to the EU budget and to the bail-out funds, and the
strongest EU economy, its views cannot be ignored (as President François
Mitterrand discovered when he went for reflation in one country in 1981 – at a
time when the economic imbalance between France and Germany was less pronounced
than today). In any case, Germany has eurozone allies in its emphasis on
austerity, such as Austria, Estonia, Finland, Slovakia and Slovenia, and to
some degree the Netherlands.
Nevertheless, Hollande has every right to tell Merkel that
the strategy into which Germany has pushed the EU needs amending: by imposing
too-rapid reductions of budget deficits on problem countries, it is decreasing
their ability to repay their debts. According to the IMF, the ratio of gross
public debt to GDP in Spain, Italy, Ireland and Portugal will rise every year
between 2008 and 2013. The EU’s strategy is also stimulating waves of political
populism, extremism and anti-EU sentiment in many parts of the Union.
The French and German bureaucratic machines put enormous
pressure on their respective governments to forge compromises on difficult
issues. Hollande probably has enough sense to try to work with the Germans
rather than against them. That will mean accepting and ratifying the fiscal
compact that the Germans care so much about. He may also have to accept at
least modest doses of structural reform. He would then be in a strong position
to ask the Germans to be flexible in other areas.
Hollande should prioritise two initiatives. One would be to
give the problem countries a greater number of years in which to cut deficits and
reach fiscal targets. In Greece, the steepness of the spending cuts has made
output fall so fast – GDP is almost 20 per cent below where it was five years
ago – that the debt burden has become unsustainable. The deficit reduction
targets that Spain has had to adopt – more than 5 per cent of GDP from 2011 to
2013 – may have a similarly harmful effect. There is a fine line to be drawn
between two lax an approach, which allows governments to postpone painful
choices on spending, and may lead the markets to lose confidence in their
ability to repay debts; and excessive austerity, which may smother so much economic
activity that markets lose confidence in governments’ ability to repay debts. But
Hollande should give a clear message to Merkel that spending cuts are being
imposed too quickly in some countries.
Might the Germans be flexible on this point? Two days before
the second round of the French presidential election, I was in Berlin talking
to government officials. They were obdurate in saying that deficit reduction
targets should not be and would not be relaxed. However, most EU governments,
the Commission and the IMF believe that the problem countries need to be given
longer periods to reduce deficits. Merkel will find it hard to resist them all.
A second priority for Hollande should be to encourage
Germany’s leaders to facilitate a rebalancing of their economy. If Germany
invested more, consumed more and imported more, it would help to reduce the imbalance
between its massive current account surplus and the current account deficits in
Southern Europe. For an economy of its great size, Germany has unusually low
levels of consumption. If one tells Germans that the structure of their economy
is contributing to the eurozone’s ills, they generally don’t like it. They also
tend to say that a government cannot have much influence on whether citizens
choose to spend or save.
But the good news is that the German economy seems to be
doing a bit of rebalancing of its own accord. Investment is increasing. Consumption
has risen over recent years (though, until recently, less than overall growth).
A report from the IMF this month foresaw the possibility of domestic demand
leading a German recovery. Imports from the eurozone are rising – for example
there has been surge of wine imports from Spain. According to the Federal
Statistical Office, Germany’s trade surplus with the rest of the eurozone in
the 12 months to the end of March 2012, of €62 billion, was 29 per cent down from
the previous 12 months (though some economists believe these figures are
unreliable).
Even better, Germany’s leaders seem to have – finally –
woken up to the need for rebalancing. Jens Weidmann, the Bundesbank president,
has said that Germany might have to tolerate inflation that was a little higher
than the eurozone average. Wolfgang Schaüble, the finance minister, has said
that higher wages for German workers could help to combat eurozone imbalances.
It had hitherto been a taboo for government ministers to comment on wage
settlements.
If Germany experienced higher domestic demand and wage
inflation, South European countries could more easily export their way out of
recession. Hollande should urge the German government to encourage these
trends, for example by cutting VAT and telling employers that it is relatively
relaxed about wage inflation.
The political crisis in Greece makes it urgent for Merkel
and Hollande to find a modus vivendi. They should tell the Greeks that if they
wish to stay in the euro they cannot avoid austerity and structural reform. But
to raise the Greeks’ morale the EU will have to relax Greece’s deficit reduction
targets, write off much more Greek debt and think more imaginatively about how
to encourage external investment in Greece. Merkel will find such policies
harder to embrace than Hollande. If Greece moves towards exiting the euro, the
EU will have to focus on ensuring that contagion does not affect other
member-states. The EU would then need to enlarge its bail-out funds and prepare
other emergency measures. Once again, Hollande’s role will be to work with
other EU leaders in nudging the Germans to be flexible.
If the Germans spurn such efforts they will risk sacrificing
not only their special relationship with France but also many of the
achievements of 60 years of European integration. Until recently, many German
leaders seemed disconcertingly certain that their policies for dealing with the
eurozone crisis were absolutely right. Now some of them understand that at
least some of their policies are not working. Hollande and other EU leaders
need to explain to them that an inflexible Germany risks becoming isolated.
Comments
The US took care of the 2007-08 crises in a very elegant way, providing enough liquidity and made sure everybody understood that there was no way they would let this crises escalate further. In Europe we do it the other way around.
Good luck!