France and Friends Are Letting Germany Conquer Europe

France and Friends Are Letting Germany Conquer Europe

Without fundamental fiscal reform, the economies of the European periphery will be weak and increasingly subject to Teutonic domination.

Swedish, Finnish and Danish experiences should bolster confidence in the power of such structural change. Having followed Berlin’s lead, all these countries have shown better economic performance and stronger national finances than France and Europe’s periphery. Between 2009 and 2013, these three Scandinavian countries grew in real terms at annual rates of 3.0, 1.0 and 0.6 percent, respectively, hardly a powerful performance by longer-term historical standards but vastly better than the outright declines registered in Spain, Italy and France, for example. What’s more, the Scandinavian countries’ growth, by raising tax revenues and curtailing demands for social services, has put their public finances on a much firmer footing. They have reduced their budget deficits, in most cases to within the EU’s acceptable parameter of 3 percent of GDP, and so they have kept their outstanding debt burdens lower relative to GDP than elsewhere.

The Organisation for Economic Co-operation and Development (OECD) provides another authoritative source of reform guidance. Drawing on the experience of all its members, both inside Europe and outside it, the OECD has developed a thorough review of the structural reforms that, in its own words, have a proven ability to “enhance long-run productivity and growth performance.” The organization’s research, presented in a series of studies under the title Going for Growth, professes to tell nations not just “where to go” but also “how to get there.”

The wealth of analysis and recommendations in the OECD’s book-sized reports go beyond the scope of an article like this. In summary, it is fair to say that much of its work resembles the Hartz Reforms. On labor-market policies, for instance, the OECD would encourage hiring by making firing easier and less costly. Similarly, the OECD identifies great potential gains from efforts to reduce the cost of labor by cutting payroll taxes and by decentralizing wage bargaining, especially moving from national contracts to company-by-company negotiations. Less a part of Germany’s reform but identified by the OECD as significant are efforts to increase competition within domestic markets by, for instance, removing internal protections for inefficient, established firms and sweeping away regulations that impede entry by new competitors. Pointing to successful reforms made in Norway, the Czech Republic and the Netherlands, the OECD also recommends a simpler tax code that reduces statutory rates and makes up the revenue difference by sweeping away subsidies and applying taxes more broadly throughout each nation’s individual and business populations.


STILL ANOTHER reform blueprint emerges from the efforts of Italy’s former prime minister, Mario Monti. He was well aware that every nation in the OECD’s study that adopted such reforms grew faster and achieved lower rates of unemployment and a better fiscal balance than those that failed to reform. He was even more acutely aware of the need for an alternative way to promote growth while Europe’s periphery remained unable to give up budget austerity. Structural reforms, he made clear, were the only option for Italy and for Europe’s periphery in general. Though diplomacy no doubt prevented him from promoting such reforms explicitly as a way to shed dependence on Germany and so avoid German dominance, he surely must have thought about it.

Monti set out a reform agenda for Italy in 2011. Though he never drew the parallel explicitly, it looked remarkably like the Hartz Reforms. He began with an effort to liberalize Italian labor markets, making them more flexible by easing rules on hiring and firing, allowing wage negotiations to proceed company by company instead of on a national level and giving management more freedom to set work schedules. He also looked to alter unemployment compensation in order to encourage displaced workers to seek training and return to the workforce. Though such labor-reform efforts have failed in Italy’s past, Monti was able to use the exigencies of Europe’s crisis to move the government to action. The progress he made, though far from complete, was remarkable, especially given the powerful interests vested in those old labor rules. The last two times Italy tried to relax its restrictive labor laws, in 1999 and again in 2002, the Red Brigades paramilitary organization murdered the leading lights of reform. This time, not even all the unions opposed the changes.

Monti had to leave his efforts incomplete, however, because, for reasons unrelated to reform, his coalition collapsed and Italy had to call new elections in 2012. Monti, never a politician, could not prevail. Yet while he was making his biggest push in 2011 and early 2012, these sorts of reforms did gain adherents elsewhere in Europe’s beleaguered periphery. Spain, Portugal and even Greece pushed similar changes. Clearly, the fiscal-financial crisis served as a considerable lever with which to move entrenched opposition aside. The OECD analysts behind the Going for Growth series noted a marked uptick in interest during that time, especially from Spain and Portugal. But lately, enthusiasm about such progrowth reform has ebbed, no doubt because the intensity of the crisis has also ebbed, though no government to this point has substantively unwound its former reforms.

France would seem to be an exception. Though the intensity of the crisis has dissipated there, too, Paris faces an alternative source of pressure. All three major credit-rating agencies have downgraded France’s standing. Since the agencies have encouraged structural change as a remedy for France’s troubles, Paris, unlike the others, has felt obliged at the very least to increase its conversation on the subject. Paris began to talk up reform last spring and even implemented rule changes at the time that at least gestured at the available reform models. In 2014, President François Hollande has again talked of reform in what he called a probusiness agenda. Acknowledging that Paris cannot redistribute if there is no wealth, he vowed to remove the burdens on business. As per much of the reform advice, he promised in particular to slash payroll taxes and wasteful government spending.

So far, however, French efforts have been more apparent than real. Admittedly, Paris has made it marginally easier to hire and fire and has made unemployment compensation less attractive, but it has done little to help displaced workers gain additional skills for new jobs. It talks about reducing the cost of labor, but, last spring, rather than lighten overall employment tax burdens, Paris merely shifted them from direct payroll taxes to the value-added tax. And Paris has only offered selective tax relief. More recent statements promised more earnest efforts to cut taxes and pay for the lost revenue with spending cuts, but those statements notably lacked specifics. Nor has Paris done much to promote competition. Instead of encouraging efficiency by easing barriers to entry into French industry, Paris so far has left all its old regulations, subsidies and special accommodations in place. Its substitute is a scheme of subsidized financing for firms in what it calls the “sectors of the future.” Hardly the “competition” the OECD and the rating agencies have recommended, this is an extension of government control and government subsidies for its favorites. Meanwhile, the present government has raised individual taxes and reversed many of the small reforms of its predecessor.


THE WAY it looks right now, France and Europe’s periphery will fail to embrace structural reform sufficiently. Unless they accelerate their efforts, they, stuck as they are with their budget constraints, will face ongoing recession or at best economic stagnation. They will consequently remain dependent on Germany and so increasingly be subject to Berlin’s influence. Perhaps if the euro zone were really a single coherent whole, as its elite so earnestly claims, weakness in the periphery would not lead so directly to rising German power. In such a world, financial and economic burdens would be more diffused and ambiguous, making it easier to argue that the burdens, wherever they fell, served the union’s general needs. But as it is, Europe is not yet such a coherent whole. Burdens and requests for help are associated with nations. And the citizens of those nations doing the lifting will naturally demand compensation in one way or another for bearing those burdens. Such demands will manifest themselves in claims for greater control and leadership.

This crucial difference between elite dreams and reality became painfully clear in an otherwise insignificant incident late last year. A group of smaller German banks, called Sparkassen, complained to the ECB about its monetary policy. The decision to hold interest rates low, the banks argued, helps Europe’s periphery at the expense of German savers. What they said is true, of course. The deeply indebted periphery benefits from low rates, as Germany’s earnest savers suffer low returns on their assets. German media picked up the story and, knowing the popularity of the message, broadcast it widely. What most highlighted the contradictions in Europe’s reality was the way the ECB’s president, Mario Draghi, responded. Instead of dealing with the Sparkassen’s argument, he chided them for their “nationalistic undertone,” insisting that the members of the ECB Governing Council are “not German, neither French nor Spaniards nor Italian” but instead “are Europeans,” and the ECB is “acting for the euro zone as a whole.” By clumsily pretending that these burdens and benefits did not fall along national lines, Draghi only managed to emphasize how few “Europeans” there really are, at least as he uses the term, and how many Germans and Spaniards remain, one to carry the burden to help the other.