During the past two years, Germany and France have driven growth and debt talks in the Eurozone. Now the two economic engines of the Eurozone are slowing down, and bilateral friction is increasing.
From ‘Merkozy’ to ‘Merde’?
“It is extraordinary that we get questions on frictions and divergences during a joint press conference. The very aim of this press conference is to show there are none,” French finance minister Pierre Moscovici said on Tuesday, sitting next to Wolfgang Schäuble, German finance minister.
Moskovici vehemently denied any friction between the two nations. In turn, Schäuble said Germany would “never dare to judge France’s economic decisions.
Between 2010 and 2012, the German-French alignment promoted a strong focus on austerity programs across Europe. Germany enjoyed an excellent and somewhat surprising growth performance. France tagged along.
In comparison to what’s to come, those early years of the Eurozone crisis were days of wine and roses, characterized by the Merkel-Sarkozy cooperation, or the Eurozone’s economic ‘Merkozy’ engine.
Today, the growth of these twin engines is slowing down. Germany is stagnating, France is in a recession.
After President Sarkozy was ousted from Élysée Palace, Francoise Hollande has been shifting the French position toward an emphasis on growth, while Chancellor Merkel has continued to promote austerity.
Now the Eurozone is characterized by rising friction driven by the disagreements between Merkel and Hollande – the Eurozone’s sputtering engine that the critics call less politely ‘Merde.’
Demise of German export-led model
In Germany, the slowdown of economic activity in the second half of 2012 will be morphing into recessionary conditions in early 2013. That’s when the Eurozone crisis will finally catch up with Europe’s largest economy. In markets, this is contributing to increased uncertainty. As export-led growth is eroding, Germany is hoping to rely on private consumption, but the latter is crumbling and cannot compensate for the slowdown in export growth.
In national politics, Merkel continues to have strong support. However, political opposition has steadily increased in states and cities. In the fall 2013 elections, her conservative CDU may not survive without an alignment with the German social democrats. However, whether Germany will be led by the CDU or SDP, German voters will increasingly oppose fiscal transfers, debt mutualization and expansive bailouts.
Lingering French consumption
In Paris, the June election victory of Francois Hollande and the socialists has not resulted in a rebound in economic activity. The slightly-stronger than expected Q2 performance had more to do with political cycles than business cycles.
While Paris may meet its budget deficit target in 2012, official growth forecast for 2013 is far too ambitious, taking into consideration the eroding economic environment in France and the Eurozone.
Unlike in Germany, the French GDP is driven by consumption. As Hollande has opted for highly redistributionist taxation policies, which will discourage French business, he is trying to foster budget discipline, which will discourage consumption. Instead of focusing on structural labor market reforms that France desperately needs, Élysée Palace risks alienating both its companies and citizens.
The subsequent policy readjustment – EUR 20 billion tax relief for enterprises – does not reflect the kind of structural reforms that are required for the pro-growth policies that Paris advocates. On Monday evening, Moscovici presented a competitiveness plan, which outlines plans to reform French labor market and bring the public deficit and debt within EU thresholds.
Paris is in a hurry. For all practical purposes, Europe is about to enter a medium-term stagnation, or a lost decade.
Economic deterioration, political radicalization
In the past, the German-French cooperation kept the Euro Titanic afloat. Now the erosion of these economic engines and their political collaboration is contributing to market uncertainty. In the coming months, the Eurozone GDP will slow down, stagnate and fall.
Naturally, significant differences in economic performance will prevail between the core and the periphery, but the core economies are no longer immune to the adverse feedback loops.
Across the Eurozone, domestic consumption will linger and slow down economic performance over a year or two. The policy effect will not reduce the impact, but is likely to magnify it. As austerity programs are implemented Southern Europe (Greece, Portugal, Spain, Italy) and in the core economies (France), they will dampen private demand – which is vital to growth in Northern Europe.
In the coming months, even larger economies in Southern Europe will need lifelines to sustain the transition. For all practical purposes, that may well result in requests of assistance by Spain in 2012/2013 and by Italy by mid-2013.
In turn, the vicious circle of austerity, lingering demand, plunging exports, shrinking credit lines, increasing uncertainty, and reduced investment will be reflected in rising uncertainty and in unemployment. And that is likely to result in political radicalization and militant extremism over time, in both right and left.
German focus on austerity is necessary, but not enough. French emphasis of growth is vital, but not sufficient. In the coming years, only cooperation and compromise between Germany and France can sustain the Eurozone through its debt crisis.