Can Francois Hollande avoid the Euro Train Wreck?

At the moment, the Euro Area is stagnating, unemployment is rising and the entire banking system is dangerously fragile – in Nouriel Roubini’s phrase, we are watching a slow motion train wreck. But if the opinion polls are right, Francois Hollande will very soon be President of the French Republic and economic policy in the Euro Area (EA) could become decisively more progressive. ‘Austerity’ could be ditched and Europe could go for growth and jobs. It goes without saying that such a turn of events would have very important repercussions for Britain.

Whether such change is possible, however, depends on a number of factors difficult to evaluate; e.g., how markets will react, how Hollande manages the relationship with Germany in the coming months, whether the German SPD can form a government after the 2013 general election and, crucially, whether social democrats in the EU scrap the current economic orthodoxy. Let us consider each in turn, bearing in mind the speculative nature of any such discussion.

Francois Hollande and the Mitterand Inheritance

How will markets react to a progressive government in France? The knee-jerk reaction is to invoke Mitterrand’s experience in 1981-3 when financial turbulence forced the social democratic left to change course within two years and into ‘cohabitation’ within five. And, yes, it must be added that financial markets are far more powerful today. Nevertheless, there are important differences. First, the once-powerful French Communist party (PCF) is no longer of any significance, so there is no red revolution to fear. It is easily forgotten, too, that Mitterrand’s policy failed largely because of rising inflation which rocketed in 1983.

An even more important difference is that today financial markets have become aware that fiscal austerity leads to a dead end. Far from leading to budget balance, deep expenditure cuts leads back to recession which makes things worse – as we see in Greece, Portugal and Ireland and will soon see in Spain too. Hollande’s message is simple: in a recession, fiscal rectitude is achieved through state-led growth – it is higher national income that generates higher savings, not the other way ‘round.

Doubtless there will be capital flight from France as a result of higher taxes on the rich, but it is unlikely to be massive. Young middle-class French people migrate not because of high taxes but because there are too few jobs, and the extra income from higher taxes on the rich – and from clamping down on tax dodges – can be used to create jobs. Unlike the early 1980s, the French today are far more aware of the inequities of neoliberalism and the time-bomb of unemployment.

Francois Hollande’s Tasks ahead

Hollande’s most difficult task upon coming to power will be calming the Germans while renegotiating the so-called Stability Treaty. There are two issues here. First, Angela Merkel, by openly backing Sarkozy, has declared war on the Hollande camp, presumably because she believes that by so doing she can preserve her own brittle CDU-FDP coalition government. But even assuming she can remain in power until the German general election deadline of September 2013, her popularity is on the wane and numerous polls suggest the most likely electoral outcome to be either an SPD-Green coalition or else a ‘grand coalition’ without Merkel.

The second – and crucial – issue is that of the Stability Treaty. This Treaty requires countries wishing to borrow from the European Stability Mechanism (ESM) to adopt a German-style ‘debt brake’ law limiting their structural fiscal deficit to 0.5% of GDP. As shown in detail elsewhere , the debt brake law is only possible in Germany because of the country’s current account surplus – it is economic nonsense to think such a law can resolve the problem of deficit countries (this is not a matter of Keynesian economics but follows from simple National Accounting identities).

Although many EA governments are in the process of ratifying it, the Treaty is deeply unpopular - and not just in Greece, Portugal and Ireland. In Italy, Mario Monti has made it clear that he thinks it foolish and that jointly-backed Eurobonds constitute a better solution. Belgium’s Guy Verhofstatd agrees and even Mr. Barroso appears to support this position. In demanding that the Treaty be changed, Francois Hollande would have the support not just of the EA periphery but of some of its major players and many of its economic experts. One should bear in mind that the poll indications for Italian Parliamentary elections to be held next spring suggest a centre-left coalition will emerge. Whether the Germans and their Dutch and Austrian allies could long hold out against a majority of the larger EA economies is doubtful.

In short, a victory of Francois Hollande on the 6^th of May might well mark a turning point for the economic future not just of France, but of the EU and of Europe as a whole. While the chain of events outlined above is necessarily speculative, what is certain is that the coming 15 months will see fascinating changes take place. After all, two centuries ago France’s revolution embedded the Enlightenment values of liberté, égalité, fraternité which inform the European centre-left today, values which today’s Europe disregards at its peril.  Without a growth strategy, the euro – and the European project – is doomed.