Almost all economists and many politicians now accept an apparently outlandish view expressed on this page many times since the mid-1990s: that, as a result of its own mishandling of unification and the euro project, Germany has become the sick man of Europe. What is still controversial is whether the whole Continent is condemned to follow Germany’s long-term decline, or whether a new source of economic dynamism and political leadership might emerge in one of its other great nations.
My hunch has long been that France would supplant Germany as the most important economy in Europe and that its superior economic performance would help it to reassert the political dominance it enjoyed in the 30-year span from General de Gaulle to Jacques Delors. I now feel much more confident in making this prediction — and much more optimistic about the future of Europe — than I did even a few days ago.
The reason for this confidence is quite simple. In the early hours of Tuesday morning, Francis Mer, the plain-speaking industrialist who became Finance Minister after the recent election victory of the French Right, found himself outvoted by eleven to one in the committee of euro-zone Finance Ministers. M Mer’s reaction to the vote, which related to demands for reductions in national budgets under euroland’s notorious Stability Pact, reminded me of Churchill’s apocryphal response when he found himself similarly outvoted in the Cabinet: “The vote is eleven-to-one; it seems we have deadlock.”
Instead of bowing to the “peer pressure” from fellow ministers, who were demanding that France show its allegiance to the Stability Pact by announcing at least some symbolic tax rises and spending cuts, M Mer openly put French national sovereignty ahead of the Maastricht treaty. As the other finance ministers, European Commission officials and central bankers expostulated against France for sabotaging the pact and undermining confidence in the euro project, M Mer explained his position as follows: “We decided that there are other priorities in France.” Boosting economic growth, creating jobs, raising military spending and honouring President Chirac’s electoral promises to reduce taxes, were all more important objectives than arbitrary deficit targets.
Why do I attach such significance to a diplomatic tiff that might normally be dismissed as a storm in a teacup? First, because the French economy could do much better than expected in the years ahead, provided M Mer and his masters follow a pro-growth nationally orientated economic policy, defying the deflationary “peer pressure” from other European politicians, the Commission and the European Central Bank (ECB). Secondly, because other European governments will gradually follow the French line, if it proves economically successful and popular. Thirdly, because a conversion to expansionary economic policies by the national governments of euroland will eventually force the ECB and the commission to abandon their pre-Keynesian economic dogmas. Finally, because the balance of power in Europe will shift decisively in favour of France and against Germany, if macro-economic policy favours more growth.
I will concentrate in the rest of this article on the first and last points — about France and Germany — since the second and third are obvious enough to require little elaboration. If France does well by cutting taxes and pursuing a laxer fiscal policy than the one demanded by the Commission and the ECB, other countries will surely follow. As this happens, the commission and the ECB will be forced to adjust to the new economic reality by changing their own rules and operating procedures.
Let me return, then, to the key issue — whether France would improve its economic performance by defying the Stability Pact and following a more expansionary economic policy. The answer is unequivocally yes. In an environment where interest rates are set by the ECB at far too high a level for the health of the European economy, fiscal policy is the only answer for a nation that wants to cut unemployment and restore economic growth.
Tax cuts may fail to provide an economic stimulus only in one situation — where a country’s budget deficit and public debt have risen to excessive levels, casting doubts on the long-term sustainability of a lower tax regime. These conditions emphatically do not apply to France. The French budget deficit is 2.5 per cent of GDP and national debt is 58 per cent of GDP. While these are quite close to the Maastricht treaty limits of 3 and 60 per cent respectively, they are perfectly tolerable levels by any objective standards for an economy with 9 per cent unemployment which has just suffered two years of near-recession.
Assuming M Mer can achieve his very modest target of 2.5 per cent economic growth next year, the government deficit would start to fall of its own accord, as a result of higher revenues and lower unemployment. And if global conditions deteriorate so much as to make this growth forecast unattainable, that is all the more reason for France to cut taxes, to offset the deflationary pressures.
What about the argument that easing fiscal policy is just an expensive distraction from the real economic problems facing France, and indeed the whole of Europe? Surely “structural” issues, such as labour market regulations and excess government spending, are the real obstacles to growth? Here, I believe, is the nub of the argument for drastic reform of all economic policies in Europe. It is true that France (like the rest of Europe) needs more flexibility in hiring and firing regulations and working hours, fewer regulations and drastic cuts in the size and the cost of government bureaucracy. But these so-called structural reforms will not, on their own, boost economic growth. In fact, they would almost certainly increase unemployment in the short term.
Structural reforms will succeed only if they are accompanied by more expansionary monetary and fiscal policies. Moreover, in consensus-orientated societies such as France and the rest of continental Europe, tough labour reforms and drastic cutbacks in public spending will not even be attempted in an environment of high unemployment and recession. In a country with an adversarial, winner-takes-all political system, Margaret Thatcher may have succeeded in firing government workers while squeezing the economy with high interest rates and a doubling of VAT rates. But that kind of confrontational approach is unlikely to work anywhere in Europe. The voters simply will not accept it, as confirmed by last month’s German election result.
But will it really be possible for France to make economic headway, simply by cutting taxes and easing fiscal policy? Won’t the bloated public sector, the 35-hour week and all the other regulations, prove huge impediments to growth?
This is where the relationship with Germany comes in. If France’s main competition in global markets came from America or Britain, all the structural rigidities might indeed prove insuperable hurdles. But the opportunity now facing France, and other countries such as Italy and Spain which may choose to follow its expansionary economic example, is to take advantage of Germany’s self-inflicted weakness.
Germany suffers from all the same regulatory and structural disadvantages as France and Italy but it carries two additional burdens. It locked itself into the euro at a cripplingly high exchange rate, which means that the cost of employing a worker in Germany is 45 per cent higher than in France and 60 per cent higher than in Italy. As a result, new investment will haemorrhage out of Germany into other euroland countries as soon as conditions become more favourable to growth.
Now it has re-elected a Government that is planning to raise taxes, increase regulations and push labour costs even higher. And to make matters worse, this Government does not even understand modern macroeconomics and is therefore unwilling either to force the ECB to slash interest rates or to pursue a fiscal expansion to pull itself out of its deflationary black hole.
Sooner or later even Germany, will doubtless follow the French example if expansionary policy proves successful. But by that time the economic and geopolitical shift will have been achieved. The leadership of Europe will again reside in Paris, not Berlin.
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