Wednesday 13 June 2012

War by other means: The emerging economic and political divergence at the centre of Europe

Christopher Wood

Two leaders, two agendas: Angela Merkel and Francois Hollande were keen to talk of continuing their commitment to European cooperation after the French Presidential Inauguration, yet it is unclear if national concerns can be overcome. AFP, Odd Andersen.

THE BRANDENBURG GATE– an iconic monument in the heart of Berlin, a five-minute walk away from the Reichstag that sits directly on the intersection of the Tiergarten and the historic core of the German capital. Crowning its neo-classical architecture is a reminder of one of Europe’s most bitter rivalries amidst its long and war-torn annals of history – cast in a resplendent and vast bronze statue, the goddess Victory stands astride a four-horsed chariot, her gaze fixed permanently across Pariser Platz square upon the building that contains the French Embassy. 

The relationship between the two most powerful economic entities in Europe, despite being beset by prolonged periods of mutual animosity and outright warfare, has been central to European politics. Today’s ‘special relationship’ is a product of over 70 years of Franco-German cooperation that has evolved from Cold-War realpolitik to the shared European vision that we see today. 

After ten years of monetary union under the Euro single currency, dark clouds are gathering over Europe. Greece has been toiling under the burden of drastic austerity imposed by the European Central Bank and its German financiers for over a year with little success. The financial health of vast swathes of Southern Europe is increasingly being questioned by credit rating agencies and creditor nations. Barely a month into office, the newly-elected French President has issued a rallying call for a fresh approach to the European fiscal malaise in the form of growth-inducing stimulus – in doing so, Francois Hollande has compromised the stoic German commitment to enforcing structural reform and debt servicing. Are we witnessing the end of the Franco-German consensus that has been so central to the European project?
Revolutionary France? Not quite.

Gone are the days of ‘Merkozy’ – the seemingly symbiotic relationship between the previous French President and Chancellor Merkel of Germany was often derided in the face of German economic vitality and largesse in comparison to that of France, and Mr. Hollande appears keen to dispel any aspersions of ‘junior partner’ in his relationship with the German Chancellor. In a move that has seemingly undercut a year of European unanimity in support of the German insistence for austerity, Hollande has been swift in establishing a uniquely French vision for solving the current financial crisis. 

Growth, he believes, is key, and he has made it clear that he is willing for France to use government spending to stimulate its economy. France’s already-burgeoning public sector looks set to be the biggest beneficiary of his pro-growth election pledges. The creation of some 60,000 new teaching positions and new investment in schools alongside a four-figure annual increase in the number of newly-recruited police officers took centre stage in his Presidential campaign, and it is hard to see any movement to renege on these commitments. Government spending also seems to be Hollande’s answer to one of the pervasive ills of the Mediterranean economies – in a bid to deal with widespread youth unemployment, Hollande has promised the creation of some 150,000 public sector jobs targeted at graduates and school-leavers. 

These are vast commitments for any deficit-laden nation to be undertaking at this time, and Hollande’s proposed increases in French national expenditure are not solely limited to direct public sector employment. Tax breaks for small and medium enterprises, coupled with the creation of a ‘public investment bank’ for the provision of cheap government loans to small successful companies and start-ups looking to expand, hints at protectionist measures designed to nurture home-grown talent. The fact that manufacturing businesses choosing to locate their businesses to France have also been promised favourable public financing and tax incentives suggests that Hollande is willing to sanction competitive measures against other European economies to foster French economic growth. 

Such policies are moderate, if not conservative, in nature and extent. Had they been suggested as little as three or four years ago, they probably would have failed to lift a single eyebrow. What is more, Hollande has also committed himself to matching or bettering his predecessors record on public sector efficiency savings, as well as balancing government expenditure and revenue by 2017. What must be considered, however, is the timing and context of such commitments. By making it clear that government intervention through direct spending and tax incentives can rejuvenate the French economy, he is setting a dangerous precedent for economic competition between countries within the Eurozone, many of whom can ill afford to engage in fiscal stimulus and the subsidisation of industry.

Who’s leading who?

Chancellor Merkel and the German paymasters behind Eurozone bailout at the German Bundesbanke stand stoically by the view that only through restructuring and liberalising can failing national economies have any hope of increasing their national competitiveness and addressing their balance of payments deficits. The fact is, the German programme for recovery along the lines of deep public sector cuts and pro-market liberalisation has uniquely failed in inspiring growth, or even engendering support in the nations that are at the centre of the Eurozone crisis. The problem remains that further austerity lacks appeal for voters within these nations who have grown accustomed to generous social security, and wealthy corporations and individuals who revel in lax tax practices. Implementing an adapted German model of manufactures-led growth through internationally competitive private enterprise has little chance of success in nations without a strong manufacturing base, or the finances to develop one.

Hollande has upset the balance of political power within the Eurozone through this pro-stimulus rhetoric simply by presenting a course of action that the likes of Greece, Spain and Portugal can realistically pursue. The status quo that existed previously was a unanimous, but implausible, commitment to austerity that essentially has failed to yield results. Hollande has established himself as the preeminent spokesperson for fiscal stimulus, and the voters and incumbent governments of the wavering and vulnerable Southern and Mediterranean nations - Greece, Spain, Portugal and Italy – are inevitably asking themselves whether austerity can deliver.

The painful truth is that none of these nations, save perhaps Italy, are in any position to start throwing money around in an attempt to encourage economic growth. In all of these countries, a wasteful and inefficient government expenditure is a major cause of their financial woes, and pumping more money into the economy without sweeping reform and widespread belt-tightening would only serve to further bloat lagging economies. Not only that, interest rates for further government borrowing in these nations are creeping ever-higher – a state of affairs that makes government spending prohibitively expensive, if not severely damaging. Austerity needs to be enforced, and any prospective stimulus package needs to yield quick results to end the prolonged and damaging speculation over Europe’s growth outlook.
Government Bonds, 10 year yields: Y-axis figures are the levels of interest paid by the respective governments to bond holders. General trends: German downward momentum, French currently double that of Germany, Spain levelling at about 5 times that of Germany and Greek interest on government bonds at an unsustainable 30%. (Source: Trading Economics).
Holding out for a hero

It is clear that whilst government spending may be capable of vitalising the French and perhaps Italian economies from lacklustre and sluggish performance, it is hardly a viable solution to the European debt crisis. There may, however, be a way for the flagging economies of Europe to realise their newfound hopes of spending their way back into prosperity, should they continue to cut the fat in their own economies and invest wisely. The issuance of ‘Eurobonds’ and the creation of a Europe-wide debt pool would allow the stronger economic performance of the Northern nations to effectively subsidise the borrowing rates for those economies wilting under the burden of hostile lending markets – lower interest on government lending for these nations would allow them to pursue stimulus packages, at the cost of exposing the Northern economies to increased risk, and thus upping the price they pay to borrow.

The prospect of Eurobonds raises the prickly question of further European federalisation, and has only served to further divide the French and German leadership, with Hollande in favour of the programme that could see Europe take a large step towards the realisation of a European super-state. A growing and vocal German public resentment at paying for other nations to spend ineffectively, plus the prospect of losing Germany’s incredibly strong borrowing position, pits Chancellor Merkel in opposition to further economic integration. It may be a bitter tonic that the Germans have to swallow in order to save the Eurozone – should the Euro fail upon a Greek exit due to a lack of any cohesive plan for recovery and growth, Germany will pay a very high price indeed along with the rest of Europe for their current economic hubris.

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