The Entrance Of Hollande In The Euro Crisis
The Article: Austerity and the euro crisis: Add Hollandaise sauce in the Economist.
The Text: TEN YEARS ago Romano Prodi, the-then president of the European Commission, created a stink when he declared that the euro zone’s budget rules were “stupid” because they were too rigid. But with the onset of the euro zone’s debt crisis in 2010 the response has been to try to make them even stiffer.
At Germany’s insistence, the euro zone first gave the commission more powers to monitor and enforce deficit limits, including the threat of “semi-automatic” sanctions for rule-breakers. And second, almost all members of the European Union were dragooned into signing up to the fiscal compact, a new treaty requiring then to adopt binding balanced-budget rules, preferably in their constitutions.
The election of a Socialist, François Hollande, as France’s new president, is causing a rethink in Brussels. There is certainly a change of rhetoric about a “growth compact”. But in substance, the change may be rather modest.
To begin with, Germany says the text of the fiscal compact is non-negotiable, a position that Mr Hollande’s lieutenants seem to understand. Instead they want some form of programme to promote growth to be created alongside. Whether this takes the form of a formal protocol attached to the treaty (which must also be ratified), or a looser agreement, is yet to be decided. But with parts of Europe back in recession, leaders agree that they have to be seen to do more to promote growth.
In truth, the idea of growth was never absent from the European response to the crisis. Summits have been debating the issue since January. But fundamentally, in the view of Germany (adopted in large measure by the commission) growth would come firstly from restoring market confidence, by getting a grip on public finances. And secondly it would come from supply-side structural reforms to make countries more competitive and labour markets more flexible. With the rise of Mr Hollande, there is now a greater focus on boosting demand as well.
Although he belongs to the European People’s Party, the same centre-right political grouping as France’s defeated President Nicolas Sarkozy, the current commission president, José Manuel Barroso, warmly embraced Mr Hollande and his call for growth. “I am extremely pleased to see the new momentum that is clearly building in our member states to kick-start the stalled engine of growth,” he said at a press conference today.
Far from being stupid, says Mr Barroso, the euro zone’s budget rules are intelligent, because they allow for “adaptability” – though precisely how they can to be adapted remains to be seen (more on this below).
Mr Barroso was careful to say there should be no let-up in deficit-cutting, let alone a splurge of public spending. “Debt-fuelled growth is unsustainable”, he insisted, adding that Mr Hollande emphasised his commitment to bringing down France’s deficit.
So what to do about growth if there is little or no more money available? One proposal is to recapitalise the European Investment Bank (EIB), which has started to cut back on lending for fear of losing its credit rating.
Another is to leverage uncommitted bits of the EU’s budget, in collaboration with the EIB, to raise new joint “project bonds” to finance new infrastructure projects. A modest sum of €230m could generate €4.6 billion worth of projects, says the Commission. It argues that such investments, for things like trans-national electricity grids and pipelines, would not take place if left to member-states.
These ideas are sensible. Channelling the funds through the EIB, provides some assurance that the projects make economic sense and are managed properly. But even if countries agree to provide the EIB with the extra €10 billion that the commission is calling for, nobody should think that such extra money will lift the most troubled parts of the euro zone out of their recession.
There is a danger, moreover, of assuming that just because some European-level investment can be of benefit, all European spending must by definition be good. Sadly, this is what the commission is doing when seized the moment to urge members to support its demand for an enlarged EU budget, both for next year and for the seven-year period starting in 2014. “It will be a contradiction to support growth through investment and not be able to commit the funds necessary to work for that at the European level,” declared Mr Barroso.
It is not, surely, a contradiction to point out that an organisation that still spends about four-tenths of its budget on agricultural subsidies is failing to make the best economic investments.
The commission’s proposals are not new, but it is pleased that Mr Hollande has already made them his own and hopes he will champion them. “We are seizing the moment to advance our previous proposals in the new political climate,” said Olli Rehn, the economic and monetary affairs commissioner.
The novelty may come in the coming days. The European Commission is in the final throes of debating proposals to relax the deficit-cutting targets. The IMF has made clear its view that the adjustment in European countries has often proven to be too harsh. Its latest work on the effect of fiscal consolidation finds that, in a downturn, deficit-cuttting has a strong multiplier effect that pushes countries into unexpectedly deep recession.
Mario Monti, Italy’s prime minister, does not seem to have made much headway in his call for spending on “investment” to be excluded, wholly or partly, from the reckoning of a country’s deficit. Instead, the Commission may agree to give some countries more time to get their deficits below 3% of GDP, the threshold set by the euro’s original Stability and Growth Pact. This is what Mr Rehn had to say in a speech on April 5th:
Contrary to the misleading impression promoted by some politicians and pundits that the EU fiscal framework forces all member states into a ‘one-size-fits-all’ consolidation straightjacket, the Stability and Growth Pact is not stupid. Yes, the EU fiscal framework is rules-based, with clear reference values for public deficit and debt for triggering the excessive deficit procedure and, if needed, sanctions. But, at the same time, the Pact entails considerable scope for judgement, based on economic analysis and its legal provisions, when it comes to its application. The Pact underlines the structural sustainability of public finances over the medium term and implies differentiation among the member states according to their fiscal space and macroeconomic conditions.
All this verbiage probably spells “less pain in Spain”. Last year it posted a deficit of 8.5% of GDP, substantially higher than its target of 6%. It has been allowed to overshoot its target this year, on condition that it keeps its promise to get the deficit below 3% of GDP next year. Though it is not officially asking for a reprieve, Spain may be granted an extra year to make the target.
An obvious time to announce the change could be Friday May 11th, when the commission is due to issue its spring economic forecast (which will then form the basis of detailed “country-specific” recommendations at the end of the month).
That said, the commission wants to see greater evidence that Spain is making the full effort to control public finances. It wants to see the budget cuts that Spain has promised this year, and evidence that Madrid is getting a grip on spending in the regions. The commission also wants Spain to draw up a convincing plan to stabilise its troubled banks. Moreover, the commission may push Spain to commit to a two-yearly budget cycle to provide greater clarity. “The road to medium-term economic sustainability goes through immediate decisive action in structural reforms and financial stability,” said Mr Rehn.
Any move to lengthen the process of bringing down the deficit will have to be weighed against two factors. First is the impact on the markets: will investors fear that such a move heralds the breakdown of fiscal discipline, or rejoice that recession might be less deep? And how to explain the favour done to Spain to other countries, such as Belgium, that were told to cut the budget more deeply to meet their target, or face sanctions?
Whatever the “Hollande effect” on European policy towards public finances, the new French president is likely to be confronted with an uncomfortable decision. The commission’s economic forecast is likely to find that, on current policies, France is likely to miss its 3% target next year (the IMF reckons the deficit will be 3.9%). So even before he is formally installed as president, Mr Hollande may be asked to spell out how he intends to keep his promises both to control debt and to relieve Europe of the curse of austerity. Unlike Spain, France is unlikely to get a deadline extension.: it cannot claim to have done everything possible to control the deficit, or that it is the victim of an unexpectedly severe recession.
Europe’s budgetary policy may be getting a dollop of Hollandaise sauce, but beneath it all it will still be the same austere dish.
