France’s indecent proposal is an affront to policymaking

Published in Business Spectator (Melbourne), 23 October 2014

This week, the French ministers for finance and the economy were visiting Berlin. Probably aware of the frosty reception Prime Minister Manuel Valls received on an earlier trip to Germany (An acid test for French-German diplomacy, 25 September), they decided to announce their visit with a deliberate provocation.

In a joint interview with the conservative German broadsheet Frankfurter Allgemeine Zeitung, Michel Sapin and Emmanuel Macron made an indecent proposal to their German colleagues they were going to meet.

To avoid any confusion among Business Spectator readers, the following is not a piece of satire and your columnist has not made it up. This is indeed a serious idea floated by the French government.

It goes something like this: If you, Germany, want us, France, to cut back our government spending then you should increase your own government spending by the same amount. How about we cut €50 billion and you invest €50bn? This way we could consolidate our budget while you make sure that aggregate demand in the eurozone does not fall.

The reasoning behind the French proposal certainly does not lack its own kind of logic. The eurozone as a whole looks to be entering a deflationary debt trap, so contractionary fiscal policy in deficit countries such as France might exacerbate the problem. Meanwhile, Germany is nearing a balanced federal budget (for the first time in decades, one might add), so obviously Berlin must have some room for manoeuvre. Voilà: you can square the euro monetary circle by putting one foot on the fiscal accelerator in Berlin and another on the fiscal brake in Paris. So much for French logic.

And now for the absurdity of France’s proposal.

First, the proposed cuts to the French budget are quite close to the consolidation France was going to undertake anyway. It needs to if it wants to stop its deficits from spiralling out of control. This is not a question of doing Berlin any favours but something that France will need to do if it does not want to end up like Greece. The French government, however, makes it sound almost as if they were doing Berlin a favour by getting their budget in order. This underlines the nonchalance with which the French still treat their own budget crisis.

The second problem with France’s demands to Germany is that they do not make any sense for France. Why would a German investment program do anything to help the French economy? Say Berlin agreed to ‘stimulate’ its economy by building new motorways, railway stations, schools and airports. How much of this spending would actually result in orders for French companies? Probably not much.

It is highly unlikely that such a German domestic stimulus would result in large spillover effects for the French economy. You cannot compensate French public austerity with German public spending. These may be two economies joined in an unhappy monetary marriage but they are not working like a single, domestic market. When was the last time a French company built a German Autobahn?

The third problem is that for the German government to invest more, it would need to borrow more first. Yes, Germany is close to a balanced budget but it does not sit on a pile of cash that it could just deploy. In any case, it makes absolute sense for Germany to reduce its debt load in order to avoid future calamities.

Currently, Germany’s official debt-to-GDP figure stands at around 80 percent. However, Germany’s demographic profile requires it to reduce this debt load now because it certainly will not be able to deal with it easily once the baby boomers have retired and its dependency ratio skyrockets.

By all accounts, France’s proposal is just ludicrous. And yet, one might even feel a little grateful for Messieurs Sapin and Macron for making it.

First, it highlights why monetary union between countries as diverse as France and Germany cannot work. They are just not an optimum currency area in which it really would work not matter who saves and who spends. In the eurozone, aggregates are meaningless. What does it tell us if the eurozone’s current account is roughly balanced when Germany records an extraordinary surplus and others equally extraordinary deficits?

Second, France’s proposal also reveals that the French government strongly believes in a great deal of economic coordination across Europe. What Paris proposes does not sound much like coordination but more like central planning. It reveals the mind-set of French politicians who still believe that government can effectively shape the workings of a continent-sized economy.

Perhaps the worst aspect of France’s demands on Germany is that they are nothing but economic blackmail. Paris is threatening to reduce its own efforts to bring its budget under control and regain economic competitiveness through reform if Berlin does not change its own fiscal policy.

Under normal circumstances, the polite answer the German ministers should give to their French counterparts is to get lost. Circumstances, however, are not normal. Germany does not have an interest in France making itself the next centre of the euro crisis. So instead of brusquely rejecting France’s demands, the Germans have now started emphasising by how much they are already supporting German domestic demand through policies such as the introduction of a minimum wage, increases in pensions for mothers and scheduled infrastructure programs.

So this is how economic policy is now made in the eurozone: Make absurd proposals based on spurious logic and threaten to commit economic suicide in order to blackmail your neighbours into ridiculous policies. You do not have to be a staunch eurosceptic to find such tactics counterproductive, to say the least.

The eurozone has long been stuck in an economic cul-de-sac. The longer the malaise drags on, the more one gets the impression that it is in a political dead end, too. You cannot find reasonable policies anymore if this is how they are discussed.

If Europe’s economic and political decline were not so serious, the theatre the French government is currently performing could be a laughing matter. Sadly, it is not.

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