President Hollande Should Propose an Ambitious Growth and Integration Agenda for the Eurozone

The election of François Hollande will not lead to dramatic changes in economic policy in France and Europe, comparable to what happened after the election of François Mitterand in 1981.  Since the failure of the economic program agreed by the socialist and communist parties in 1983, all governments in France have agreed to respect the double external constraints imposed on them: the economic constraint that requires preserving firms’ competitiveness, and the political constraint that requires preserving the European Union’s “acquis” and the good relations with Germany.

This does not, however, prevent French governments to negotiate with their European partners, as was the case in June 1997 following the accession of the Socialists to power.  At that time, the new Prime Minister, Lionel Jospin, and his Finance Minister, Dominique Strauss-Kahn, asked to renegotiate the Growth and Stability Pact that had been adopted by the European Council in Dublin in December 1996.  This caused some tension, but in the end, the new French government agreed to support the Pact in exchange for advances in terms of economic policy coordination and social policies.

Clearly François Hollande would like to repeat this successful operation and obtain to complete the fiscal compact with growth-oriented measures.  His explanations on what he intended to propose suggest he will not require a radical change of economic policies.  While this might be good news for the Germans, financial markets might be disappointed given the current economic conditions in the eurozone.  Erring on the side of caution might be as futile as the excess of ambition shown by Mitterand in 1981.

A growth compact to support aggregate demand and businesses

The economic downturn in the eurozone is worrisome not only because it is significant but also because governments seem powerless or unwilling to do anything to counteract the downturn.  Fiscal policy is paralysed by the level of indebtedness and the commitments taken in the fiscal compact.  Monetary policy has lost its effectiveness because of the fragility of many banks and the reorganisation of their funding within each country’s national borders.  Structural policies generate positive results only in the medium and long term.  In these circumstances, the only hope of a recovery relies on the positive impact of austerity and reforms on market confidence and interest rates.

One is entitled to raise doubt about the speed at which confidence will come back.  It would therefore be prudent for the eurozone leaders to react by adopting a strategy that would stimulate aggregate demand and strengthen companies’ competitiveness.  The following measures could be an integral part of this strategy.

  • Automatic stabilizers: Eurozone governments should agree to stop taking new austerity measures in 2011 and define next year’s budgetary consolidation in terms of structural measures (for instance 0.5% of PIB) and not in terms of specific reduction in deficit and debt ratio.
  • Monetary supply: The European Central Bank (ECB) should find ways to repair the process of monetary creation.  The current annual growth rate of M3 (2.8% in February) is too low compared to the implicit target guiding ECB monetary policy (4.5%).  If the ECB believes that the transmission of monetary policy could only be improved if the banking system is recapitalized, it should state it publicly to convince governments to address this problem quickly, possibly by allowing the European Financial Stability Facility (EFCF) to take stakes in banks.
  • Targeted investment: Eurozone governments should also launch a program of investment to strengthen the competitiveness of the economies of Southern Europe and reduce the degree of wage reductions that is required to allow these economies to compete globally.

The adoption of a growth compact would not mean, of course, that fiscal discipline should be abandoned.  To avoid any ambiguity, the eurozone governments should reiterate their commitment to ratify the Fiscal Treaty quickly.  They should also undertake to update their stability programs to present the structural reforms they will implement to get them back to balanced budgets.

A debate on a new treaty on fiscal integration

Investor and business confidence would return faster if the eurozone governments would agree to further reduce the vulnerability of the eurozone to contagion.  There are two serious solutions to achieve this objective: the adoption of Eurobonds and the granting of a banking license to the European Stability Mechanism to allow the ESM to refinance itself from the ECB.

It is unlikely that the German government would agree to support this type of solution without having previously obtained a strengthening of the governance of the eurozone.  Indeed, these solutions mean authorizing a European agency to borrow large amounts of money from the capital markets or the ECB, under joint and several liability, to reduce the borrowing cost for eurozone countries at all times or only during periods of tension in sovereign debt markets.  As joint issuance would substantially raise the liabilities of Germany, any such plan would have to be matched by new rules so as to avoid a situation whereby one country would not comply with the provisions of the Fiscal Pact, thereby forcing the other countries to assume a higher debt burden.

Against this background, it would be good if the new French President would propose to launch a discussion on the institutional arrangements that would be necessary to create new financial solidarity mechanisms between eurozone members.  It is to be hoped that he will not be afraid to take such an initiative because it could lead to some transfer of sovereignty.  This would be even more regrettable given that Chancellor Merkel has recognized earlier this year that she was open to the idea of Eurobonds in the longer term, at the conclusion of a process of deeper economic and political integration.

8 Responses to "President Hollande Should Propose an Ambitious Growth and Integration Agenda for the Eurozone"

  1. guest   May 7, 2012 at 5:44 am

    how do they love the creation of a transfer union , eurobonds and a federal europe.
    so the european political elite,the federalists and europhiles will win some time again and can live in denial another 10 years before the final verdict .

    the eurozone will not work,cutural impossible.

    • Gopalan Ramachandran   May 7, 2012 at 8:54 pm

      Ten years is a long, long time. There is too much at stake. The pace has to accelerate; the real effervescence has to show up sooner. Europeans are getting older faster and their fertility is falling faster. Francois Hollande is relatively young – and I have no ill-will at all for the dapper Nicolas Sarkozy. Monsieur Hollande should make the younger Europeans seek the rewards of entrepreneurial earnings.

  2. DiranM   May 7, 2012 at 9:52 am

    Yes, they love this like the Soviet communist elite, who had their perks and power. Hail the Soviet Union of Europe!!! The collective always precedes freedom and individuality.

    In the meantime, who are the sucker investors who are going to drink the Kool-Aid and buy these Eurobonds that are part of their giant Ponzi scam? In the end, they will probably be obliged to put this on the ECB, which had already an insanely leveraged balance sheet.

    Why are Euroweenies always so dreadful in their math and financial skills???

    • Gopalan Ramachandran   May 7, 2012 at 9:02 pm

      What a pertinent assessment! The Europeans have to learn the math of engagement, work, markets, prices and prosperity. Their semi-frozen neighbors in their east new the math of disengagement, lazy leisure, coupon lines and canteens, prices and poverty. Wake up, Europe, wake up. You don't want to die old and poor. Choose fertility over austerity. Show some pluck and cheer now. The berries and the cherries will be succulent and bright.

  3. benleet   May 7, 2012 at 9:57 am

    Labor market competitiveness is fundamental. The German growth must be balanced with increased wages to German workers, cutting back profitability on the German ownership end. Concentration of wealth and a sustained advantage in export markets gives the "winners" an unassailable upper-hand, driving slow growth and increasing debt burdens in slower periphery countries. From an article at Dollars and Sense magazine: The huge gap in unit labor costs gave Germany a tremendous competitive advantage and left the southern eurozone economies at tremendous competitive disadvantage. As a result, their trade flows changed dramatically. The four southern Eurozone economies and Germany all had modest current account deficits (the broadest measure of a trade deficit) in 2000. A decade later Germany enjoyed a current account surplus of 5% of its GDP, while the southern eurozone economies were saddled with a current account deficit of 5% of their GDP. —- see this link:
    I mention all this because the US has the same wage differential imbalance with trading partners such as China and Mexico. The global economy has a huge imbalance to correct.

  4. commonsense   May 7, 2012 at 7:22 pm

    Is it time for the world governance body to listen to the economists instead of the investors whom are protecting their wealth "nothing wrong with that" for the whole common purpose of stability, prosperity and a world where " you play by the rules, work hard, maybe a little harder, you should be able to provide for yourself, and your family and live in dignity"