Something to cheer about (2008)

Here we depict a few macro stories that will forcefully attract market attention going forward (if they haven’t done it yet). While at a first sight there seems to be little tying stories together, we deem that all stories have the potential to significantly impact on the evolution of future events, as they question the need of change in regard to existing policies and institutions. To us, this is in itself something to cheer about.

Consumers to get a bigger share of the pie, at last

The single market revisited.The coming year will test the European Commission’s commitment to proceed with the completion of the single market, and ensure that the increased openness will directly benefit European citizens and small firms. This “new cycle for the single market” represents a radical shift in Brussels’ emphasis with regard to consumers. Traditionally, consumer policy has focused only on consumer protection, while the new course promises to empower consumers through more information and the provision of choice in order to ensure that they “effectively reap the benefits of market opening and find it easier to understand how the single market can work for them”. Among the concrete proposals, there is the creation of a new set of tools encompassing a greater focus on implementation and enforcement, the simplification of existing legislation where possible, the reduction of unnecessary red tape as well as the introduction of policy systematic evaluation.

Eventually, this overdue step comes from the recognition, supported by several studies, that consumer may play a key role in putting pressure on firms to innovate and become more productive. Crucially, the rejection of the European Constitution in May 2006 by France and the Netherlands has also shown that Europe cannot further advance without citizens’ support. At that time, popular resentment against Brussels was inspired by European policies’ alleged failure to deliver on promises and preserve jobs from the threats stemming from globalisation. These arguments have been often nurtured by politicians’ Brussels-bashing aimed at deflecting people criticism about their ineffective action. It is thus all the more inspiring that the European Commission takes nevertheless up its responsibilities for not having always best monitored markets opening and ensured that it produced its intended effects to consumers. It presents some evidence showing that the impact of the dismantling in January 2005 of the multifibre arrangements (a 40-year old system of quotas for textile and clothing), while on average positive, has varied widely across the EU, spanning from a nearly 50% decline in real clothing prices in UK to almost no impact in Italy and Spain.

Convergence in thinking, a fluky coincidence? Addressing ways to improve consumer welfare has become increasingly pressing as recent strikes in Germany and France have pointed to a renewed wave of resentment across the eurozone against markets integration, which allegedly is putting increasing strains on European workers’ purchasing power. Resentment flared up anew amid increasing fears that reform momentum in Europe could further come to the expense of consumers – already severely hit by the sharp rise in oil and food prices. In this environment, it may not be a fluky coincidence that the European Commission’s shift toward a “more targeted and impact-based” competition policy comes rightly at the same time in France the Attali Commission to liberate growth puts the consumer at the centre of the discussion. The Attali Commission has recommended a liberalisation of the labour market, the injection of more competition into strictly regulated retail and services industries and the creation of an independent competition authority to empower the consumer. Mr Mario Monti, the former EU competition and member of the Attali Commission, suggests that a quiet revolution in France is taking place, most notably among the members of the Commission. He claims that it could represent a first step to break the ancestral antipathy towards free market competition that run deeply in the French culture. Moreover, he believes that many of these reforms, if implemented, have the potential to transform France from an administered economy into a market economy at a clear and substantial benefit to consumers.

Shall we owe it also to Sarkozy? Paradoxically enough, we should eventually recognize that the evolution in Brussels thinking may owe also to Sarkozy, who has played a key role in questioning the efficacy of competition policy’s dogmatic stance in delivering “best returns” for consumers, growth and job creation. Though still clinging on the misperception that “free and undistorted competition” represents a goal instead of a mean to ensure market discipline and stands in the way of national champions emergence, he may have provided a stimulus for reshaping the single market in the 21st century and placing competition into a broader context.

Europe forces through less benign neglect

Shift in bias…Increasing tensions in the currency market – with the euro bearing the brunt of the dollar slide against dollar-pegged currencies and especially the renminbi – have induced the representatives of the major European institutions to abandon their usual posture of benign neglect with respect to the low valuation of the Chinese currency. Until recently top officials had indeed kept deflecting any specific question about the Chinese currency’s steady depreciation against the euro by referring to the G7 communiqué. This attitude has primarily mirrored internal divergences about which institution was entitled to commenting upon exchange rates and, more fundamentally, the lack of a common policy across all members. However, the risk of a full-blown dollar crisis with formidable consequences for the stability of cross borders capital flows has prompted a clear shift in bias in Brussels and Frankfurt towards a more activist attitude vis-à-vis exchange rates. It eventually induced the ECB’s President Trichet, the President of Eurozone Finance Ministers Junker and the European Commissioner for monetary and economic affairs Almunia to plan a trip to Beijing and press on currency and trade issues. While the meeting did not mark any dramatic departure of China from its long-standing position on the renminbi, namely one of “perfecting the exchange rate in a gradual, proactive and manageable manner”, it certainly represented a major step towards improving EU relationships with China, often uneasy because of disputes about human rights issue.

…to calm markets and restore confidence…We deem that the recent shift in attitude could become a theme of particular interest to investors going forward, in that it may effectively help to contain financial markets volatility, all the more so if the United States will wisely follow suit. In fact, the coordinated verbal intervention of the above-mentioned three top officials sent a clear message to markets that Europe is concerned about the dollar’s slide and stands ready to take appropriate action to smoothly correct imbalances. That was a necessary and overdue move to firmly dismiss the idea that the dollar’s dominance as a reserve currency was coming to end. Looking forward, it is likely to expect further concerted action from European leaders to put pressures on China to take upon its responsibility as a global player. But, as Mr Pisani-Ferry has rightly argued it, Europe should be ready to accept the price that would come with this increased cooperation from Chinese authorities, namely a reduction of its overrepresentation in international institutions in favour of China. Hopefully, common sense will eventually prevail.

Fiscal policy, the buffer to tough times

A common feature across major eurozone members will consist in a pause in the pace of fiscal consolidation, with countries taking advantage of the fact that their deficit-to-GDP ratios had fell anew to a fair (as in the case of France) up to considerable (Spain, Germany) distance below the level permitted under the Stability Pact. To be sure, the situation is very diverse across the “Big Three”. On the one hand, following strong improvements on the consolidation front, Germany and Italy have switched from a restrictive to broadly neutral fiscal stance. The revenue windfall from stronger than expected growth in previous years will be assigned to reduce the tax wedge, especially on corporates (in Germany), and finance discretionary spending. On the other hand, France justified its decision to pursue a mildly expansionary fiscal stance with the willingness to create a confidence shock across the country – an allegedly necessary condition to push through far reaching reforms and boost growth potential.

A buffer…Intriguingly, countries do not seem to have fully learned the lessons of 1999-2000, when extra revenues arising from the better-than-expected cycle were used to increase expenditures or reduce taxes, rather than consolidate the budget. Eventually, as the business cycle entered a phase of prolonged slowdown, i.e. the “good times” came to an end, countries were forced to adopt unpopular measures to trim the deficit and contain the ballooning debt, i.e. cutting spending or increasing social security contributions. The risk is that history might repeat itself. But as far as the near term outlook is concerned, a neutral to mildly expansionary fiscal policy will certainly provide a positive stimulus to GDP growth. This will help countries buffer the headwinds from ongoing market turmoil that will soon start to be felt across the eurozone. Amid renewed tensions in the interbank market and a sharp depreciation on the dollar vis-à-vis a broad basket of currencies, growth projections embedded in budget plans will soon start to look overly optimistic if they haven’t done it already – it is the case of Spain. Ceteris paribus, this eventually risks translating into upward pressures on the different levels of governments to increase discretionary spending beyond original plans. Therefore, while we envisage for 2008 only a 0.1 pp increase in the eurozone deficit to GDP ratio up to 1.0%, we deem that risks are tilted toward a more significant deterioration of public finances.

…with the usual caveats…It is worth stressing that governments have not adopted a loose fiscal stance that would have forced them to openly confront themselves with the rules of the Stability Pact. Structural adjustments are only postponed. However, the major risk we see in this lack of direction is that it undermines the credibility of fiscal policy and, as a consequence, may eventually bring lower than expected support to growth.