Friday, 4 May 2012

A possible change to Europe's austerity

The French presidential elections on Sunday will be followed by elections to the parliament in June. So if all the opinion polls are right, France will have a new president and a new majority within a few weeks.

For Europe this could have a significant effect. Francois Hollande, who appears to become France’s next president has been very clear that he wants changes to the current “Fiscal Compact”, the code name for Europe’s German-inspired austerity programs, by which all Euro-zone member state must have cut their budget deficits to 3 per cent of GDP by 2013.

Data released this week point to a sharp downturn in the economic activity in Southern Europe and in France. Economic activity is also stalling outside the Euro-zone and unfortunately there is no other explanation than government cutbacks. All of this will eventually hit Germany, whose growth is strongly dependent on the growth in the export markets. With the rest of Europe slowing, Germany’s economy is bound to follow.

All over Europe voters are throwing out politicians who have been managing the crisis and are now connected with the austerity programs. The “hard core” of the Fiscal Compact is crumbling. The Dutch government has resigned as the far-right PVV refused to support domestic budget reductions. In Finland, the True Finns party has adopted a similar position.

This creates an interesting situation. Will Hollande cave in, faced with Merkel and Schäuble, and give up on his election rhetorics? Or will Merkel and Schäuble realise that keeping Europe on track will require that France is fully on board and that this can only be obtained by relaxing the economic policy? Most pundits expect the first.

My guess is that Germany will “cave in”.

In practical terms it could imply that the 3% budget targets will be postponed by a year or two. All kinds of EU funds will be used to provide assistance in long term financing to southern Europe. It will reach from Infrastructure funding to long term financing. Portugal and Ireland will probably be able to negotiate a 1-year extension of their bail-out loans.

All of this will happen in the face of determined resistance from the Bundesbank.

Does it sound too good to be true? Well, maybe. But Germany is not controlled by a strict economic philosophy alone. There is a political dimension to it as well, and Chancellor Merkel is a politician with strong instincts.

Having failed to explain to German voters what the packages to Greece, Portugal, and Ireland were all about, Merkel is now facing German voters fed up with “paying for Europe”. Local elections in the coming days will give an important indication of the strength of the dissatisfaction. If the results are a strong showing for the Social Democrats, Merkel will be weakened politically and will need to adopt her policies well in advance of the next national elections to be held in 2013.

The only way of getting out of that situation is to make sure that growth will resume soon. So far Germany’s leading politicians and Bundesbank have acted as if Germany alone was immune to the crisis. That perception has allowed them to treat lack of growth in the other European countries with something akin to disdain.

A combination of a crumbling Eurozone “hard core”, a sharp drop in exports and political resistance from German voters could change Merkel’s mind.

On top of that, remember that for the longer term political prospects in Europe, Germany cannot afford to alienate France. Germany needs Europe as much as Europe needs Germany.

If I am not right in assuming that growth will be back on Europe's political agenda, things could get worse than they are now. I hope I am right.

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