The euro’s political weak spot

France’s turbulent politics make economic reforms tricky to implement: Fidelity

While the plan to unify Europe after World War II began with two Italians,[1] the French pounced on the idea. The first concrete step occurred in 1950 when the French government called for the creation of a unified military in western Europe as a step towards a political federation along the lines of Australia’s. The same year Paris proposed the joint administration of French and German coal and steel resources to shift these war-making ingredients out of German control.

The six-member European Coal and Steel Community that was formed in 1951 is considered the birth of the EU. Its “common assembly” is now the European parliament. Along the way, the French drove the creation of the euro, a currency Germany adopted to gain Paris’ support for German reunification in 1990.

But the fate of the proposed pan-European military force could provide more lessons for what lies ahead for the eurozone. In 1954, the French parliament failed to ratify a treaty allowing the military pact, in part due to concerns about threats to French sovereignty. With it went any chance of forming a proper federation across Europe.

Over the years, the French have taken other steps to stymie European integration. In 1961, Paris vetoed the UK’s admission into the then European Economic Community. In 1964, Paris sabotaged a US-led effort to form a political and military union across Europe by making economic threats to thwart German participation. In 2005, it was the turn of French voters to reject European integration, when they voted against a treaty designed to transfer more power from national to central control.

The danger for Europe is that France’s ailing economy is making its politics volatile and as antagonistic towards Europe as it was during these episodes. It’s possible that a collapse of support for the ruling Socialist party and an intra-party rebellion that led to the government’s dissolution in August, a paralysis of French leadership in Europe, Paris’ policy frictions with Germany and the rise of populist parties at a time when France’s right-wing mainstream party is mired in corruption scandals will block or even reverse the meshing that Europe needs to restore its prosperity. The political climate could even lead to France quitting the euro.

Given how much the French have woven Europe together, it’s hard to believe a French government under the mainstream political parties would torpedo the euro, unravel Europe’s integration or idly allow outside forces to wreak similar damage. Any economic recovery could derail the rise of populist nationalistic forces. In the past, France and Germany fought over policy even as they integrated Europe. Surely, they can weld Europe closer together nowadays even as they stoush over solutions. The truth, though, is that France’s politics are haywire enough for the country to pose indirect and direct threats to the eurozone and the euro in particular.

Woes and blows

France’s political turmoil is due largely to its economic ills but it also stems from the country’s long disquiet about globalisation because of the challenges modernity poses to uncompetitive monocultures and the power of “the state”, which has elevated status in France.

France’s high-tax, over-regulated, protectionist and government-heavy economy – public spending amounts to a eurozone-high 57% of GDP – is sick enough and big enough to threaten any European recovery as the country of 63 million amounts to 16% of the eurozone economy. France is basically in its sixth year of recession or near recession. The economy is barely above its size in 2007, having recorded zero growth in 2012 and a meagre 0.3% rise in 2013, partly because the government is imposing austerity.[2] Concerns about deflation are mounting – French consumer prices only rose 0.6% in the 12 months ended July this year. Unemployment is hovering around 11% or 3.4 million registered jobless. The ratio of government net debt to GDP has soared to 97%,[3] even though (or perhaps partly because) Paris has withdrawn stimulus worth an estimated 5% of output over the past three years. Labour costs rising at triple Germany’s rate over the past decade (30% versus 10%) have made the country less competitive and it now runs a persistent current-account deficit.

France’s economic woes have helped make François Hollande the country’s most unpopular president of the Fifth Republic that began in 1958 – his approval rating is just 13% – even more so now he has upset his Socialist Party supporters by untangling France’s rigid labour market and giving business tax cuts. France’s economic troubles and Hollande’s poor standing have led to Paris exhibiting little sway in eurozone political decisions that could have long-term consequences. Hollande, for instance, was absent from the debate over appointing federalist Jean-Claude Juncker as EC commissioner in July, even though UK Prime Minister David Cameron warned that Juncker’s selection could lead to the UK pulling out of the EU.

The divergence between the economic performance of France and Germany is leading to clashes within the partnership that wove European integration. One big quarrel is over fiscal policy. France’s central government, which hasn’t recorded a budget surplus since 1974, is struggling to meet EU laws to rein in its budget shortfall to 3% of GDP by 2015. The desire by Paris (and Italy) to loosen Europe’s fiscal compact of 2012 angers Berlin, which is mustering economies in far worse shape than France to comply with the financial oversight it has implemented to protect German taxpayers from bills to backstop the euro.

The other big collision is over monetary policy. France wants the European Central Bank to engage in quantitative easing to stave off deflation, help fight unemployment and undermine the high euro. Germany, with its inflationphobia, expanding economy and less reliance on price-sensitive consumer exports sold outside the eurozone, rejects such demands. Berlin thinks that, as well as risking inflation, ECB asset-buying will allow France and other laggards to ease back on structural reforms – in strike-prone France’s case, such measures include trimming the public sector and labour reforms. Given such tensions, it came as no surprise when Germany in July blocked France’s push to install its former finance minister Pierre Moscovici as the EC commissioner for economic and monetary affairs.

The Paris and Berlin clashes, which extend to disputes over other remedies such as EU-financed stimulus spending, eurobonds, a fiscal union and a banking union, pose an indirect but existentialist threat to Europe. If the two biggest euro-using economies are feuding, hopes fade that eurozone countries can agree to the political decisions and compromise that are needed to nurture Europe through its debt crisis. “A crisis in (France) could … push the eurozone to breaking point,” warns UK-based think tank, the Centre for Economics and Business Research.[4]

The target

French politics is an even bigger direct menace for the euro, even if that dénouement might still be three years away and it might appear a low possibility. But, if the threat materialises, it will be lethal for the euro. The peril stems from the collapse in standing of the two mainstream parties, the centre-right Union for a Popular Movement (UMP) and Hollande’s Socialist Party, and the simultaneous rise of Marine Le Pen’s populist, right-wing and euro-hating National Front. So upbeat is Le Pen, now almost the de facto opposition leader, she hopes to win the presidency in 2017.

Le Pen’s optimism is based on the triple shock that France’s political system suffered in May that The Economist says “could affect French politics for years”.[5] The tremors were that the National Front won the European elections after garnering 25% of the vote, the Socialist Party scored its worst result at a national election, receiving just 14% support, (after having flopped at council or local elections in March), and a party-financing scandal ripped through the UMP and forced its leader, Jean-François Copé, to resign.

Since then things have got worse for France’s political elite that Le Pen paints as corrupt, out of touch, uncaring and incompetent. For the UMP, the post-election blow came on July 2 when former French president Nicolas Sarkozy (2007-12) and, still a possible UMP 2017 presidential candidate, became the first former head of state to be detained in a criminal investigation, which led to charges against him of corruption and abuse of power. Sarkozy’s defence that he is being set up by a rotten state, judiciary and police, implicitly justifies Le Pen’s venom towards the political class.

For the Socialists, there have been two post-election lows. The first occurred on August 25 when a left-wing revolt erupted over adhering to austerity policies. Arnaud Montebourg, then minister for the economy, sparked a crisis when he rebelled against the “absurd” austerity policies that spring from the “excessive obsessions of Germany’s conservatives”.[6] Hollande’s order for Prime Minister Manuel Valls to form a pro-austerity cabinet, the fourth of his presidency, pits the government against the social unrest brewing over fiscal stinginess. (France has a so-called semi-presidential system, where the cabinet, though controlled by an elected president, is responsible to parliament. The government needs to be dissolved to allow a cabinet reshuffle.) The other post-election nadir came in early September when Hollande’s former partner, Valerie Trierweiler, triggered a political storm when she published a tell-all book of her relationship with the president.

France’s austerity bias will drag on the economy. Its turbulent politics make economic reforms tricky to implement. So it’s hard to see the country bursting out of its malaise. Some of what irks the French is tied to Europe’s integration and its flawed currency. Of note in this category are Europe’s open borders, petty ruling from Brussels that annoy voters, austerity and the free-market bias of the EU. But much of what riles the French is more tied to globalisation. Job losses to emerging countries, the resulting insecurity about employment and conditions in France, the threat to the welfare state from the need to boost competitiveness, the shrinkage of French’s global power, the dwindling of the state’s reach within society, rising inequality and the buffetting (Americanisation) of the traditional French way of life would exist without the EU and the euro.

Le Pen’s danger to Europe is that she is talented enough to direct all French angst, no matter its source, against one enemy and to get away with posing just one solution. Her political chicanery is to blame all France’s woes on the euro (admittedly, Europe’s biggest post-war mistake). Her remedy is to restore the franc. How Europe would cope if France were to ditch the euro is anybody’s guess. (Some analysts advocate breaking up the eurozone to save the EU.) Investors and others will need to form their own judgments if polls show Le Pen is heading towards the presidency – in July she took the lead in the first-round polls for this election; in September she beat Hollande in a second-round matchup, according to one polls.[7] Just beware that if Le Pen should win, she has pledged that on her first day in office that she will take steps to rid France of the euro and that she is willing to let “financial Armageddon” rip if other eurozone countries won’t agree to a joint breakup. “What are other countries going to do (to stop me),” she taunts. “Send in tanks?”[8]

by Michael Collins, Investment Commentator at Fidelity

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French economic statistics largely come from the IMF’s World Economic Outlook Database. Other financial information comes from eurostat, Capital Economics and Bloomberg unless stated otherwise. The history of France and the development of the EU largely comes from Brendan Simms’ book Europe, the struggle for supremacy 1453 to the present. (Allen Lane 2013).