Myth of France-Germany gulf

In: Uncategorized

21 May 2012

This is my latest column for Fund Strategy

The way it is being presented there is a great economic battle brewing in the heart of Europe. A pro-growth camp led by François Hollande, the new socialist French president, is fighting back against the pro-austerity hawks led by Germany’s conservative Angela Merkel.

This picture is misleading on several counts. To the extent there is a debate between the two sides it is exceedingly narrow. Both would no doubt like to see a return to growth but neither leader has a convincing idea of how to achieve it.

Despite all the bluster about confrontation the main difference is that Hollande prefers a little more short-term stimulus and Merkel a little less. Apart from that, and contrasting styles, all that is left is austerity and a hope that things will get better when the economic cycle turns.

The recent election results in several European countries gave impetus to the notion of a great debate. Hollande’s victory in France on May 6 was the most high profile example. But the poor showing by the two main governmental parties in Greece on the same day was also notable.

A similar anti-incumbent trend was evident in German regional elections although these had scant coverage in Britain. In North Rhine-Westphalia, Germany’s most populous state, Merkel’s Christian Democrats fell to an historical low of about 26%. The main beneficiaries were the Social Democrats, the main opposition party on a national level, and the Pirate party. In the smaller state of Schleswig-Holstein a week earlier the outcome was similar.

In each case a closer examination reveals that the opposition parties were not offering much of an alternative. Support for them should be seen as a protest vote against the national governments. Let’s leave Greece aside for the time being and focus more on France and Germany.

Hollande’s election platform was more akin to that of Barack Obama than what is traditionally regarded as socialism. The French president is neither black nor charismatic, but there were some striking similarities in the campaign rhetoric when they were both anti-incumbent candidates.

Whereas Obama talked vaguely of “hope” and the replacement of George W Bush in 2008 the Frenchman preferred “change” and the removal of Nicolas Sarkozy. Hollande’s election slogan was “Le changement c’est maintenant” (the change is now).

The two candidates also shared a strong populist aversion to the power of Big Finance. For Obama it was bashing Wall Street whereas for Hollande it was attacking the disruptive role of finance and its central place in the Anglo-American economic model.

Hollande, like Obama, favours higher taxes for the rich. In Hollande’s case the proposal was for a top tax rate of 75%.

Such proposals should be seen as a way of making austerity palatable to the wider public rather than as an alternative to it. Populist attacks on the rich help promote the idea that everyone should be prepared to make sacrifices.

The rich and their advisers are extremely skilled at finding legal ways to manage their tax affairs. The likelihood is that Hollande’s proposal will not lead to a significant increase in the amount of tax paid by the wealthy.

Hollande did make some other proposals that, on the face of it, sounded ambitious. These included increasing the minimum wage, creating 60,000 teaching jobs and lowering the retirement age for some people back down to 60. He also favoured more spending on infrastructure.

But since Hollande advocates a move towards a balanced budget any increases in spending in one area are likely to be offset by decreases elsewhere. The main difference with Sarkozy is that the previous incumbent planned to reach a balanced budget by 2016 whereas for Hollande the target is 2017.

Hollande also promised to renegotiate the proposed European Union fiscal pact to loosen its rules. Although at the time of writing Germany said it would stand fast on these it is likely, given the turmoil in the eurozone, that they will be modified in some way.

Overall then the differences between Hollande and Sarkozy were much narrower than the election bluster suggested. In many ways the key distinction was on how best to “sell” austerity to the public.

Meanwhile, again little noticed in the British media, Germany has relaxed one of the main pillars of its hawkish approach. The Bundesbank, the central bank, has said that it may be prepared to accept higher inflation in Germany. Wolfgang Schäuble, the finance minister, said that he would support the idea and that he would countenance wage rises for Germans.

The differences between the two main players in the eurozone are therefore much narrower than assumed. In many respects they are more to do with style with Merkel’s dour persona set against a relatively populist Hollande. There is also a slight difference on their willingness to countenance a short-term fiscal stimulus.

What the two sides definitely share is a strong commitment to the maintenance of the eurozone. Yet, as I have argued previously in this column, the monetary bloc is a way of evading tackling difficult economic challenges (Fund Strategy, September 12, 2011).

Until the crisis hit, the eurozone provided short-term gains for its members but avoided tackling the problem of durable growth. Germany’s exports were boosted by an artificially weak currency while the southern periphery enjoyed inflows of artificially cheap credit. The need to restructure the region’s economies to provide the basis for a new round of durable growth was pushed into the indefinite future.

Now the hope seems to be that the eurozone’s problems will go away if the region maintains its coherence. All that is needed, so they seem to assume, is a sensible set of fiscal rules that everyone is prepared to follow.

A real debate about how to restructure the region’s economies is desperately needed but the phoney war between France and Germany does not provide it.