An ‘atomic bomb’ is hovering over France’s economy
An “atomic bomb” is about to blow up in “the confrontation between Paris and Brussels.”
It was in these terms that Le Figaro, perhaps the most influential French newspaper, reported the European Commission’s near-certain rejection of President Francois Hollande’s 2015 budget on Oct. 29. That is the date the commission must issue a judgment on the French budget, which proposes a two-year delay in reducing the budget deficit to the EU-mandated maximum of 3 percent of gross domestic product.
German Chancellor Angela Merkel has insisted that she will not tolerate any such relaxation of the European Union’s new, toughened budget rules. Meanwhile, Hollande has stated repeatedly that France will refuse any demands from Brussels for more cuts.
A full-scale budget war between Paris and Berlin/Brussels looks inevitable, with catastrophic effects on the European economy and markets. But on closer inspection, this impending budget battle is no more lethal than the fiscal shadow-boxing in Washington last year.
To see what is really happening, we must understand the motivations of Merkel, Hollande and the new European Commission president, Jean-Claude Juncker. All three share the same objective: to preserve the euro, not blow it up with an “atom bomb.”
But this overriding priority is subject to several constraints. Merkel must prove to the German public that EU budget rules have been genuinely tightened. Juncker must show that his new European Commission, which takes over on Nov. 1, will be tougher than its predecessor in enforcing these rules. Yet both Berlin and Brussels must avoid humiliating Hollande.
How can these conflicting objectives be reconciled? The answer, as usual in Europe, is with bureaucratic conjuring tricks, helped by the incredible complexity of the EU budget process.
Exploiting the flexibility in all the new fiscal regulations introduced in the euro crisis, officials in Paris, Berlin and Brussels are moving toward a resolution of the French budget problem based on three factors: politics, economics and bureaucratic procedure.
Starting with politics, the key point is that while the EU budget rules were agreed to by national governments, led by Germany, enforcement is up to the European Commission. Governments, and specifically the German government, have no direct input into the assessment of national budgets. This is overseen by the commissioner for economics and monetary affairs, now Finland’s Jyrki Katainen, but due to be replaced on Nov. 1 by the former French finance minister, Pierre Moscovici. Responding to German misgivings that Moscovici might show “favouritism” to the French budget (which he largely wrote), Juncker created a new procedure whereby Moscovici’s judgments will be co-signed by another commissioner, Latvia’s Valdis Dombrovskis, reputedly a fiscal hawk.
But Dombrovskis has conveniently turned more dovish since his appointment, telling the European Parliament that “we are now gradually moving from the stage of fiscal adjustment which … has by and large been done.”
It seems, therefore, that Juncker has pulled off a clever conjuring trick. By supervising Moscovici with an apparently tough Northern European, he has satisfied German public opinion. But this “hard cop” is actually pre-programmed to support a lenient approach.
In addition, the timing of the budget judgment means that Moscovici will not bear direct responsibility for judging the French budget. For the initial assessment must be completed by Oct. 29, two days before the new commission is installed.
So political arrangements are now in place to permit a flexible approach to the French budget. But how could this be reconciled with the EU’s fiscal rules?
This brings us to economics. The commission will almost certainly refuse to accept the French budget because of its failure to meet the 2015 deficit target. The headlines about “rejecting” the French budget will thus be justified, and German opinion will be reassured.
The demands for revision, however, can be made quite moderate and acceptable to France because the commission’s assessment is based not only on a “top-down” macroeconomic analysis of the budget numbers but also on “bottom-up” judgments about the fiscal “effort” the country has made. Under the rules, the commission can defer the 3 percent deficit target until 2017 — what France is proposing — provided the bottom-up assessment shows “sufficient” effort in structural and fiscal reforms.
Better still, the commission can satisfy Germany by “rejecting” the French structural efforts as “insufficient” so far. But it can then ask that additional bottom-up structural measures be introduced in the long term, instead of demanding the immediate top-down budget cuts unacceptable to Hollande.
Beyond this political and economic flexibility, the EU’s bureaucratic procedures provide a third line of defense for France. The new fiscal rules require national budgets be submitted by Oct. 15 and give the commission two weeks to make its initial assessment — hence the Oct. 29 “confrontation” predicted in the French media. The French government then has three weeks to respond with a revised budget, and Hollande has made clear that he cannot submit any revisions to his budget to the French parliament on anything like that timetable.
Does this mean a war between Paris and Brussels? Not at all. Instead of a genuine confrontation, Hollande’s inability (or unwillingness) to implement new measures by mid-November will merely set off a new round of negotiations and assessments for the following six months — the so-called European budgetary “semester” provided for under the new fiscal rules.
Only at the end of this process, in April 2015, will the commission issue a new set of forecasts, deficits projections and conclusions, based on whatever reform “efforts” France may or may not have made. Only then will the European Commission raise the question of enforcing tougher budget demands.
By that time, the French economy will either have improved, making emergency budget cuts unnecessary — or it will have deteriorated further, making cuts impossible.
PHOTO (TOP): French President Francois Hollande (L) and German Chancellor Angela Merkel talk during a conference on jobs in Milan, October 8, 2014. REUTERS/Stringer
PHOTO (INSERT 1): French President Francois Hollande addresses a news conference at the Elysee Palace in Paris, September 18, 2014. REUTERS/Christian Hartmann
PHOTO (INSERT 2): Elected president of the European Commission Jean-Claude Juncker answers questions during a press briefing after his election at the European Parliament in Strasbourg, July 15, 2014. REUTERS/Vincent Kessler