ECONOMIC VIEW: Turning point reached as EMU battle intensifies
'We have been seeing a seismic shift in German and French fiscal policy'
Tuesday 17 September 1996
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.
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