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A taste of Hollandaise

india Updated: Jul 23, 2012 23:54 IST
Pramit Pal Chaudhuri
Pramit Pal Chaudhuri
Hindustan Times
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The French should be pleased: their country is again the swing State in the European Union (EU), though they may be in the spotlight for the wrong reasons. Francois Hollande's election as the new French president is not much about the Right and the Left but a lot more about the debate over the euro crisis - and the decline in Europe's economic standing in the world.

France is on a threshold between two Europes: parts of its economy resemble the sclerotic nations of the Mediterranean. Yet it is also the second largest European economy with solid governance structures, technological capacities and ability to turn itself around. In his victory speech, Hollande declared: "There are people who have found hope thanks to us, who are looking to us and want to put an end to austerity." On the spectrum of eurozone solutions, this type of talk would put him at the "spend your way to wealth" end rather than the "prosperity follows debt pay-offs" side. But what matters is whether his idea of a "growth pact" is based on government stimuli or structural reforms.

It helps to remember what started the eurocrisis: it was a balance of payments crisis between north and south Europe. The euro's creation led southern Europe to get the rock-bottom interest rates and rock-solid credit rating of Germany. Like a kid getting his father's credit card, the south went wild with the capital. Spain and Portugal had housing bubbles. Greece indulged in extravagant consumption. When the financial crises between 2008 and 2010 put a brake on these capital flows, only debt hangovers remained: southern Europe's cumulative current account imbalances hit 1.7 trillion euros by 2011. Europe has the ability to pay off this debt. The problem is that the savings to do so is all in the north while the debts are in the south. That's where politics came in and all that stuff of angry German taxpayers abusing Greek layabouts.

Lurking behind all this is Europe's relative economic decline. Over the past decade, the EU has become uncompetitive; its labour and wage practices have priced its exports out of a cut-throat world market. We're not talking about just losing ground to China or the US. As a World Economic Forum study noted, southern Europe is now on average less competitive than north Africa. The cheap euro decade only aggravated things.

Post-crisis, the north proffered a new social contract to the south that read like this: we provide you money, in return you carry out root-and-branch reforms. Austerity, the massive slashing of government funding, is only part of this - though it remains a particular Berlin obsession. Thus Spain has begun abolishing its tangle of labour laws. Italy has handed its finances to the International Monetary Fund. The northern Europeans are backed by the European Central Bank, the source of most of the money that has kept the continent's banking system solvent.

On the other side, are populists from the extreme Right and the extreme Left whose vote share has risen dramatically. Thus an anti-euro, anti-immigrant Geert Wilders was able to bring down a Dutch government on austerity. The two mainstream Greek parties were together reduced to a minority in this weekend's parliamentary elections, battered by a group of zany anti-EU groups. This voter anger - as Nicholas Sarkozy, Gordon Brown, Silvio Berlusconi and Jose Luis Zapatero can all attest - has been the nemesis of all European incumbents facing the polls during the present crisis.

Which is why Hollande and France are important: Paris would have been expected to be part of the frugal north. But its economy has been limping: the government is more generous than it can afford to be; unemployment is stuck at 10% and its export portfolio is stagnant. Hollande campaigned as part of the southern camp. He advocated the sort of Keynesian solutions - EU money for infrastructure projects, more money in the European Investment Bank, a watering down of last year's fiscal pact and the use of unspent EU funds to spur growth - that the austerity school dislikes and Germany hates.

It is probably true that the European rescue project has moved on from being only about austerity. Many of Hollande's demands are working their way through Brussels. The crux of the issue remains the structural reforms that have to go along with budget cuts and infrastructure spending. After the French results, Berlin equated "pro-growth" with "pro-reform." German foreign minister Guido Westerwelle endorsed Hollande's growth pact but noted it had to "deliver more growth through more competitiveness."

Optimists say Hollande will become more nuanced once he gets some financial and rhetorical sops from Berlin and Brussels. The days when Paris was the sole political driver of Europe are gone. Hemmed in by Germany, the central bank and the markets, Hollande will find room for manoeuvre to be limited. Fred Bergsten and Jacob Funk Kirkegaard of the Peterson Institute have pointed out, "Quite unlike normal central banks… the European Central Bank has been able to issue direct political demands to euro area leaders." The markets have already put the euro on their watch list. And European government bond spreads are always hostage.

Pessimists point to Hollande's lack of ministerial experience and, despite having once taught economics, seemingly shallow understanding of what afflicts the European economy today. "If Hollande has ever understood the need to cut public spending in France and introduce painful structural reforms to boost productivity," says Charles Grant, director of the Centre for European Reform, "he has kept that hidden." At best, say the naysayers, Hollande could waste a year fighting with Berlin and paralysing Brussels at a time when Europe can ill-afford such time-wasting politics.

Worse, a market backlash against Hollande, another Spanish bank bailout and a Greek default threat could plunge Europe right back into crisis. The really bad part of the last scenario would be that the core issue of reviving Europe would be simply forgotten in the mad hand-to-mouth scramble to keep the continental system afloat.