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 percent 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.
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 center-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 percent 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. Germans could support Hollande’s idea to enlarge the EIB, but are divided on whether to back Hollande’s idea for EU ‘project bonds’
Hollande’s prescriptions for the European Central Bank (ECB) – 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 liberalization. He seems oblivious to the fact that France’s very high non-wage costs of employment are one cause of relatively high unemployment (10 percent, against 6.8 percent 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 percent 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. Hollande has every right to tell Merkel that the strategy into which Germany has pushed the EU needs amending.
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 prioritize 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 percent 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 percent 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. Another priority for Hollande should be to encourage Germany’s leaders to facilitate a rebalancing of their economy.
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 percent 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.
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.