Hollande, the Winner?

Written by Hilary Barnes

Le Figaro‘s shock-horror front page for May 3 read:

“One year later and Hollande is isolated in Europe“.

On page 2, lined up to say much the same thing, were editors from Spain’s El Mundo, Corriere della Sera, and on page 3 echos from Germany.

I can see that I am about to put myself in a minority of one, but no matter. No one has stopped to look around. If they had they might have noticed that Hollande’s view on Europe appears to be winning the argument, aided and abetted by Olivier Blanchard, chief economist at the IMF.

Hollande has argued all along that the policy of austerity, as conceived by the Euro zone, is wrong, it is too precipitate, is doing more harm than good and must be supplemented by policies to stimulate growth.

European Commission Is Bending

The European Commission is now adjusting the severity of its austerity policy. On May 3 it approved a two year extension of the period within which France is supposed to meet its budget consolidation commitments, having already given an extra two years to Spain and Portugal.

Hollande has every reason to think that his view is gaining ground, although he has no doubt noted that the Commission has also told him to get working on structural reforms before it loses patience.

However, his finance minister, Pierre Moscovici, may be a little optimistic when he told an interviewer (Le Monde here) that the two extra years for France and others –and they are

“C’est décisif, c’est un tournant dans l’histoire de la construction européenne depuis que l’euro existe“, a-t-il ajouté. “On a assisté à la fin d’une certaine forme d’orthodoxie financière et à la fin du dogme de l’austérité.” Pour Pierre Moscovici, “c’est une victoire pour les thèses françaises“, qui a été obtenue “parce que nous avons une politique crédible“.

“are decisive, a turning point in the construction of Europe since the existence of the euro. We have seen the end of a certain financial orthodoxy and end of the austerity dogma. It is a victory for the French thesis, (which we gained) because we have a credible policy“.                           [Translated …]

However, if Hollande has won an argument, he has not won the battle until Germany changes its tune, of which more further down.

Patron Saint of the Socialist Party?

On page 4 of Le Figaro a gentleman from the London School of Economics, Maurice Fraser, was invited to lambaste Francois Hollande for all his government’s shortcomings (and they are many), concluding that Hollande was acting as “the patron of the Socialist Party“.

There was just enough truth in this to make it obvious that he was missing the main point, which is that Hollande has a very tenuous control over the Socialist Party, which appears to be in the process of disowning the president and his government, a process that is at work in the National Assembly and even in the government itself

“Is this a  government or a riot ?“, one asks oneself more and more often.

This was the only conclusion that could be drawn from a draft document for presentation to a Socialist Party conference in June, which denounced (and was then amended) Chancellor Merkel personally as well as her stand on austerity policy, which the French regard as the work of “conservatives” and thus unacceptable to all true socialists.

The catch is that the French government is also pursuing an austerity policy, and no one is fooled by Francois Hollande’s argument that France’s budget consolidation policy is not “austerity” – that is what they do in places like Greece and Spain – but only “rigueur” or rigorous.

It is, above all, a policy that hits demand and output and has produced unemployment rates of 26 – 27 % in Greece and Spain, and in March sent unemployment to a new record of 3.2m in Metropolitan France, approaching about 10.5 %. (The figure is published quarterly only ; it was 10.2 % in the final quarter of 2012.)

In his presidential election campaign in the spring of last year and ever since Francois Hollande has promised that he will stop the rise in unemployment. He has failed to do so, which has, of course, added to the disillusion of his supporters.

What about Germany?

Merkel and the German political world in general have two bad ideas that they refuse to drop and until they modify their position the Euro zones are going to continue to get worse.

Germany believes, first, it is doing the right thing by setting out to build a huge current account surplus, now about 7 % of GDP. It recommends that all other members of the Euro zone should be aiming to do the same thing. This is pointless.

In the Federal Republic of Germany no one takes any interest in whether Schleswig-Holstein has a current account surplus or Baden-Wurtemburg a deficit. Payments to and from persons and businesses and government institutions are balanced out through the banking system.

It should be the same in the Euro zone, but because there is not federal government or banking union (although there is a “federal” European Central Bank), member states are still seen as sovereign states, although in monetary terms that is not the case. This may change one day, but the pace of progress towards federalism is slow and popular demand for advancing towards it appears to be at an all time low.

The Question of Language

Most federal systems of government are also language unions. This makes labour mobile. Those with no job in a poor region can migrate to richer regions where there there are plenty of jobs on offer.

This happens to some extent in Europe (lots of Greeks have left for Germany, lots of French have left for London, and so on), but labour mobility between Euro zone countries is much less than within countries and is not sufficient to have a big impact by evening out on unemployment levels.

Colbertism and Accounting

Instead, paradoxically, German mercantilism makes Germany more Colbertist than the French, doing immense damage to the economies of the periphery as well as to the cohesion of the Euro zone and the European Union.

Germany’s second big mistake arises from the apparent incomprehension of the Germans when economists mention balance sheet economics.

The basic concept is simple. There are two sectors to every economy, the private sector (consumers and businesses) and the government sector (central and regional or local).

The financial surplus and deficit of these two sectors must equal zero. It is an accounting identity (actually it does not equal zero: if there is a difference, it is reflected in the external account, the balance of payments, which may be in either deficit or surplus).

In normally prosperous times, the private sector tends to have a deficit, with families taking out mortgages, buying cars on credit, and so on, while businesses finance investment to increase production capacity by borrowing money.

The public sector tends to run a budget surplus because tax revenues live up to expectations and the calls on welfare spending are under control.

The situation changes when the economy slows down or goes into recession. Rising unemployment or fear of unemployment causes consumers to be more cautious with their money; businesses find sales falling below expectations; they curb investment expenditure and may lay off labour.

Consumers and business all borrow less and try to increase their savings. The deeper the recession, the more drastic is the reaction.

The government sector finds tax revenues declining or falling below expectations. Social welfare spending increases in face of rising unemployment, and so on.

Enter John Maynard

The ideal, when there is a recession, is to allow what are called the automatic stabilisers to kick in – allow government budget deficits and debt to increase to counter balance the reduction in debt and increase in savings in the private sector.

Economists in the tradition of J. M. Keynes suggest that total demand should be boosted by public sector investment in projects that will have a long run benefit in improving the overall efficiency of the economy, better roads, faster rail connections, more optic fibre networks to increase speed and capacity of computer networks, insulation of buildings to economise on energy, you name it (but, please, not subsidies for loss making electric cars or other projects that are not commercially viable).

This will help to mitigate the effects of the recession and prevent unemployment from rising too fast or too high.

The worst situation in which an economy can find itself is when both the private sector and the public sector reduce spending and increase saving at the same time. That is a sure recipe for making a bad recession much worse.

The Anti-Keynsian Continent

It is also exactly what has been going on in the Euro zone since the financial crisis hit in 2008 and more specially since 2010, when austerity policy began to be implemented in a serious way. It is one of the basic reasons why unemployment has reached very high levels in some countries.

In practice, governments do not build up surpluses that are so big they have the resources to counterbalance a major recession like the present in one in Europe. Recessions of this calibre are rare. The previous one of similar severity began in 1929-31.

Things are even more difficult if, as was the case in the Euro zone, countries were already running substantial budget deficits and big debt to GDP ratios when the recession began. In this case, for government to try to run down debt at the same time as the private sector is tantamount to economic suicide.

However, the situation makes it easy for politicians practising do-it-yourself economics to declare (we see and hear it every day) that you can’t bring down debt by increasing debt.

Back to Accounting

Well, you can increase government debt to produce a build up in private sector savings (running down debt or deleveraging), which leaves the sum of private and public sector debt unchanged or not reduced as much as it otherwise would be.

If this means that unemployment rises less than it otherwise would, and the economy continues to grow, perhaps very slowly, but better than in contraction, then much is gained, and the public sector can begin to run a surplus again and to bring down its debt ratio when the total economy is growing normally once more.

Sovereign Currencies

This policy is always possible for an economy that has its own central bank, which can print as much money as the government needs to finance its debts (see USA, UK, Japan). Such countries (with sovereign currencies) do not go bankrupt and very rarely default on any of their payments.

It is not the same for countries that are members of a monetary union and do not have their own currency, the quantity of which they can expand at will.

It gets doubly difficult if the banks in said countries look as if they might go bust, forcing governments to guarantee the debts of the banks, which means that government debt ratios get a rocket under them, and in the case of the Euro zone debtor countries, it is no longer just the banks that may default, but also governments.

That’s is the damnable position in which Europe finds itself at the moment. It is not the German Chancellor’s fault. It is not the fault of Francois Hollande.

Mission Impossible

All the present Euro zone governments have inherited an impossible situation that goes back to the flawed design of the Maastricht Treaty and a series of horrible misunderstandings since (How could the rating agencies continue to rate the government debt issued by Euro zone member countries as “without risk” when it should have been obvious that they were just as risky as municipalities?).

One can only wonder why anyone should want to become the president or prime minister of these countries, although one must also be thankful that those that do are trying their best to get things back on track and hope that Europe is not destroyed by the eruption something like the forces that destroyed the Weimar Republic.