What President Chirac might mean to Europe
Tuesday 25 April 1995
The first part of the question is not easy to answer, for though we either know or can deduce quite a lot about his aims, there is such a conflict of objectives that it is hard to see how these might be reconciled. Thus Mr Chirac professes to support the goal of European monetary union, but in practice is probably the least committed of the three main candidates to the idea of passing power from Paris to Frankfurt.
He says that he wishes to cut the public sector deficit, but has, as mayor of Paris, supported high state spending (not to mention a large subsidy from taxpayers in the rest of France). In his speeches he has attached high priority to cutting unemployment, but there is no sign that he would be prepared to attack labour market rigidities, or cut back on social security spending, two of the reasons French unemployment has risen in all but two of the past 14 years. (Public pension costs, at 9 per cent of GDP, are second only to Italy among the large developed countries.)
In a way Mr Chirac's rectitude is unsurprising. Politicians seeking election are disinclined to be too explicit about the way their objectives might be achieved: it is easier to say what they want to do than how they might do it. What should be more worrying to financial markets is the probability that Mr Chirac does not actually understand that there is a conflict in his objectives: he understands politics but is not terribly interested in economics.
Had his Gaullist rival, Edouard Balladur, become president as the whole the financial community expected six weeks ago there would be a level of understanding that simply is not going to be there now.
It seems almost inevitable that these conflicting objectives will dog the new president for some time. Let's assume that fiscal policy is gradually tightened, as it must be to bring France towards the Maastricht objectives. The general government deficit last year was almost 6 per cent of GDP, nearly double that required under the Maastricht provisions.
French unemployment, currently 12.3 per cent, will not be brought much lower even assuming economic growth of a bit over 3 per cent this year and it is already at a level causing grave social pressures. So any fiscal tightening will have to take place against a volatile background on the labour front.
Worse, French monetary policy will have to be tightened, too, not because of any domestic revival of inflation (retail prices are up only 1.8 per cent year-on-year) but because the world interest rate cycle is turning upwards and German rates will almost certainly have started to rise before the year is out.
This really will not hang together. France desperately needs several years of growth of above 3 per cent to cut unemployment back. It also needs the twin reforms of its social security system and its labour market. But even were the need for these two adjustments accepted by the electorate, something will have to be offered in return for stomaching what in the short term will be painful adjustments.
Faster growth (which would in any case make all the fiscal arithmetic easier) is the obvious candidate.
How might that be achieved? The obvious way would be for monetary policy to be made independent of Germany, and France to cut its interest rates. But, fairly or unfairly, that would certainly lead, if not to outright devaluation, at least to the franc falling to the bottom of the 15 per cent EMS bands.
Such an outcome should not be ruled out. There are powerful political attractions in a speedy pre-emptive strike early in the new presidency: a quick devaluation during the summer. But there is an alternative line of policy which, given what we know about Mr Chirac, may in the first instance be more likely. It is mercantilism.
It is important to be clear what this might mean. France is not going to introduce explicit protectionism, for it simply cannot do so within the European Union.
What it may do is seek ways of using state intervention to boost French employment, and/or encourage a switch to French-produced goods. If explicit protection is not on, encouraging a general mood of economic nationalism is perfectly within a country's rights.
It would be quite surprising if such a policy is not adopted. The trouble is that given the integrated nature of the Continental European economy, mercantilism is not going to be very effective. A possible scenario - it is not more than that - might therefore run like this.
There will be an initial run on the franc within six weeks of the new president being installed. That will take the currency to the bottom of the ERM bands. But any move below that will be beaten off. Then for a longish period, a year, perhaps 18 months, the new team will struggle on with the same policies that have characterised French financial policy for the past decade, but with a veneer of economic nationalism laid on top.
Then at some stage, it will become clear this is not working. Growth this year and next will be disappointing at well under 3 per cent, and unemployment will resume its climb.
At that stage there will be a U-turn in French policy, involving easier money and taking on the chin the currency consequences. The devaluation could even be "sold" as a final currency realignment in preparation for a single currency, if that were still a credible objective in, say, mid- 1997.
Implications for us? The most obvious one is that France will be an uncomfortable partner in Europe for the next couple of years - and maybe a much more comfortable one thereafter.
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