ECONOMIC VIEW: Turning point reached as EMU battle intensifies

'We have been seeing a seismic shift in German and French fiscal policy'

Fudge or wait? When you don't know which way a coin is going to flip, it is probably better to admit it and think about something on which you can make a sensible judgement. So it should be with European monetary union. But do not despair, for there is something else happening which is very, very interesting indeed.

We are seeing a flurry of excitement about preparations for EMU in Germany and France. Last Friday saw a deal on the German budget, agreeing cuts in public spending, in particular on social security, which would bring the fiscal deficit closer to the 3 per cent Maastricht limit. France will this week announce a budget that will seek to do much the same. Meanwhile, Germany and France are pressing for some kind of post-EMU deal to stop countries that have joined the system from running lax fiscal policies after they have signed up. Expect some kind of agreement to be reached at the Dublin meeting of EU ministers and central bank governors on Friday.

So, it would seem, it is all go. But we are not learning from this flurry of action any new information on whether EMU will start on time, or whether it will happen at all. To an overwhelming extent this is a political decision and there is no new political information, except that Chancellor Kohl can get a budget through Parliament, which everybody knew already.

Insofar as economics are relevant, the main issue is whether a sufficiently strong recovery can be sustained in Germany and France to withstand the fiscal tightening which both countries are imposing. Here the jury remains out.

Such economic information as we have had in recent weeks simply confirms the fact that Germany is managing an OK recovery and France is not. You can see that on the left-hand chart, together with some (quite optimistic) forecasts for the next 18 months from the US bank, JP Morgan.

The next chart shows business expectations, which have perked up in Germany but show virtually no sign of doing so in France, while the third chart shows one of the reasons why: goodish export growth in Germany, but a worrying downtrend in France. Since meeting the 3 per cent limit requires a strong economic performance in both countries through 1997, the message from all this is that Germany might have some chance of meeting Maastricht criteria provided they are relaxed enough, but that it is very difficult to see France doing so unless they are redefined is some quite radical way.

But we sort of knew that, too. So what is new?

I think it is this. We have in the past few days been witnessing the early stages of a seismic shift in German and French fiscal policy which signals not just a change in their ideas about the way fiscal policy interacts with the economy, but also their ideas of the appropriate boundaries of the state.

Both countries are tightening fiscal policy at a time when the economy is very weak, but at the same time they are cutting personal taxation. That breaks the old rules in a similar way to Sir Geoffrey Howe's famous 1981 Budget, which was derided by the economic dons at the time, but which arguably created the basis for the mid-1980s recovery. The French and the Germans are in effect saying that they no longer believe that a fiscal deficit can promote economic growth, and that only tax cuts on personal income (even if more than offset by public spending cuts) can do so. This is interesting and it is new.

Even more interesting is the idea that the role of the state will from now on start to shrink in France and Germany. Nobody is putting this in so many words but look at the evidence. In Germany we have just had a budget which at last cut back the social security system and has been vigorously attacked by the unions. But there is much, much more to come. Social security spending would still, under the new plans, account for more than 30 per cent of GDP. Over the weekend the health minister, Horst Seehofer, acknowledged that these cuts were a minimal programme and Germany would have to save much more. That was just two days after the hard-fought parliamentary battle.

If it is hard to cut spending by agreement within the German system of consensus government, it may happen by the same process as the US: by revenues being cut away. You can get political approval for tax cuts even if you cannot for spending cuts. So you push through the tax cuts with the argument that tax cuts are needed to stimulate economic growth, and then, when revenues fall short of expectations, a widening deficit forces spending cuts.

That at least is the theory. One could even blame Maastricht convergence criteria for the subsequent need to trim the deficit, citing the sanctions to be agreed (if they are) in Dublin on Friday.

As for France, we will get a better picture when we see details of the budget. But expect the same pattern of net fiscal tightening plus tax cuts. Expect, too, to see a big effort to start getting the French social security system off the state balance sheet. At the weekend we had a statement from the French authorities that they were pressing ahead with a private sector pension scheme to supplement the state-run one. This would be a funded system, rather than pay-as-you-go. At this stage there is no suggestion that it will take over from the state system or represent any weakening of commitment to that. But in practice it looks as though France is seeking to establish something much more like the British system, with a basic pay-as-you-go state pension but supported by private sector schemes, which are fully funded.

This evidence might seem a bit thin to support the argument that a radical rethink of the role of the state is taking place in France and Germany: a couple of annual budgets which nibble at the problem, a few statements by politicians, some quite limited spending cuts and the promises of falling personal taxation in the future.

That is a fair criticism. The evidence is thin at the moment, the signals pretty weak. In any case, these signals about a shift of policy are to some extent drowned out by the noisy debate about EMU. But I suggest that there is enough evidence to say that a turning point may have been reached. European politicians are beginning to talk in a quite different way from the language they used five years ago. What has been happening in Britain is not so important, but the progress of the US economy, in particular its ability to cut unemployment to the 5-6 per cent region, has had an enormous effect. So too has the fact that Continental European countries compare themselves not just with North America but also with the tiger economies of East Asia, where unemployment (and taxation) is even lower.

But if you wait for the evidence to pile up, you miss the turning point. I suspect that when we look back on this period 20 or more years hence, we will focus not on the preparations for EMU as such but the change in public attitudes in both France and Germany to the role of the state. Every few days which pass reveal another building block of what will become the new model for the social security systems of Western Europe.

Suggested Topics
Start your day with The Independent, sign up for daily news emails
ebooksA special investigation by Andy McSmith
  • Get to the point
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

Ashdown Group: Trainee Consultant - Surrey / South West London

£22000 per annum + pension,bonus,career progression: Ashdown Group: An establi...

Ashdown Group: Trainee Consultant - Surrey/ South West London

£22000 per annum + pension,bonus,career progression: Ashdown Group: An establi...

Recruitment Genius: Client Services Assistant

£18000 - £20000 per annum: Recruitment Genius: A Client Services Assistant is ...

Ashdown Group: Junior Application Support Analyst - Fluent German Speaker

£25000 - £30000 per annum + benefits: Ashdown Group: A global leader operating...

Day In a Page

No postcode? No vote

Floating voters

How living on a houseboat meant I didn't officially 'exist'
Louis Theroux's affable Englishman routine begins to wear thin

By Reason of Insanity

Louis Theroux's affable Englishman routine begins to wear thin
Power dressing is back – but no shoulderpads!

Power dressing is back

But banish all thoughts of Eighties shoulderpads
Spanish stone-age cave paintings 'under threat' after being re-opened to the public

Spanish stone-age cave paintings in Altamira 'under threat'

Caves were re-opened to the public
'I was the bookies’ favourite to be first to leave the Cabinet'

Vince Cable interview

'I was the bookies’ favourite to be first to leave the Cabinet'
Election 2015: How many of the Government's coalition agreement promises have been kept?

Promises, promises

But how many coalition agreement pledges have been kept?
The Gaza fisherman who built his own reef - and was shot dead there by an Israeli gunboat

The death of a Gaza fisherman

He built his own reef, and was fatally shot there by an Israeli gunboat
Saudi Arabia's airstrikes in Yemen are fuelling the Gulf's fire

Saudi airstrikes are fuelling the Gulf's fire

Arab intervention in Yemen risks entrenching Sunni-Shia divide and handing a victory to Isis, says Patrick Cockburn
Zayn Malik's departure from One Direction shows the perils of fame in the age of social media

The only direction Zayn could go

We wince at the anguish of One Direction's fans, but Malik's departure shows the perils of fame in the age of social media
Young Magician of the Year 2015: Meet the schoolgirl from Newcastle who has her heart set on being the competition's first female winner

Spells like teen spirit

A 16-year-old from Newcastle has set her heart on being the first female to win Young Magician of the Year. Jonathan Owen meets her
Jonathan Anderson: If fashion is a cycle, this young man knows just how to ride it

If fashion is a cycle, this young man knows just how to ride it

British designer Jonathan Anderson is putting his stamp on venerable house Loewe
Number plates scheme could provide a licence to offend in the land of the free

Licence to offend in the land of the free

Cash-strapped states have hit on a way of making money out of drivers that may be in collision with the First Amendment, says Rupert Cornwell
From farm to fork: Meet the Cornish fishermen, vegetable-growers and butchers causing a stir in London's top restaurants

From farm to fork in Cornwall

One man is bringing together Cornwall's most accomplished growers, fishermen and butchers with London's best chefs to put the finest, freshest produce on the plates of some of the country’s best restaurants
Robert Parker interview: The world's top wine critic on tasting 10,000 bottles a year, absurd drinking notes and New World wannabes

Robert Parker interview

The world's top wine critic on tasting 10,000 bottles a year, absurd drinking notes and New World wannabes
Don't believe the stereotype - or should you?

Don't believe the stereotype - or should you?

We exaggerate regional traits and turn them into jokes - and those on the receiving end are in on it too, says DJ Taylor