“The problem with the euro? Impossible to leave, very hard to stay”

“The problem with the euro? Impossible to leave, very hard to stay”

PARIS – Many people think France will be the next victim of Eurozone contagion. Is this a real risk after presidential election?
It may happen, but it does not seem very likely. French bonds and CDS are basically flat since January. In the same time, bookmakers and prediction markets (intrade) give roughly a 70% victory probability for Hollande (here and here).
So, in my opinion, french election odds are priced in the markets. And markets seem to be pretty relaxed about what will happen in the presidential election. I guess they’ll wait and see what happen. Of course, a surprise is always possible : a very good score for the far leftist Melenchon, which could push Hollande further to the left in election runoff; or impredictible results, polls may be wrong. Some people even imagine a greek scenario, with Hollande as a new Papandreou discovering that books have been cooked, and that the public debt is much higher than expected. I don’t believe in such scenarios.
Markets are relaxed because if you look at programs, concerning public finances, differences between Hollande and Sarkozy are limited. Both are based on over-optimistic growth; Sarkozy wants to reduce the deficit from 4.4% of GDP to a 0.5 surplus in 2017, and debt from 89.7% to 80,2%; Hollande plans public finances equilibrium in 2017 and the same debt trajectory. Sarkozy plans to reduce public spending by 3.7%, raise taxes by 1.2%; Hollande wants to reduce public spending by 2.7 and increase taxes by 1.8. Basically, plans are the same. And should not be taken seriously : circumstances will have a very big impact on what will be done. No candidate addresses the true problem in France: low growth.

A research by Observatoire français des conjonctures économiques (based on OECD data) has noted a rising of French public spending from 2005 to 2011. That is not so good, in the age of great Eu austerity. Is government expenditure in France too high? Which sector needs the heaviest cuts?
What to cut is the essence of political choice. Everyone can find his own part of public spending that he wants to cut. Sarkozy tried to reduce public spending with a simple rule: replacing on public servant leaving for retirement out of 2. It’s a failure, because the rule is too uniform. French governments want the state always to do more, but trying to do more with less works only if you can increase productivity. And such productivity gains are hard to find. Hard choices would mean a reduction in what the state does, abandoning whole public functions. This will prove politically very, very difficult.
The other way to reduce spending/Gdp is to raise Gdp: that means structural reforms to raise growth. You can find some candidates: the french labor market is badly regulated, as lots of product markets. This kind of reform is not very popular. Sarkozy, in the beginning, asked a special commission presided by Jacques Attali to give reform ideas. He failed miserably in implementation, as shown in a book written by 2 french economists : «Les réformes ratées du président Sarkozy», by Cahuc and Zylberberg. The only market that was deregulated in the last 5 years was online gambling: this is not a great performance. 

Sarkozy has talked about the Ecb role and Germany has opposed the french. Is the Paris-Berlin axis in discussion?
This is a groundhog day campaign: we are reliving always the same debates. Sarkozy asked for a change in the Ecb mandate… in 2007. Even in 1997 prime minister Jospin wanted to renegociate the stability and growth pact! You know what happened next: nothing. In the end, political and economic reality win. Political reality: It would require agreement from all eurozone members, and this won’t happen. Economic reality: the French need the eurozone.

Hollande is called “the evil statalist” by several bankers. Is it true? If Hollande win, which scenario for France?
Nothing much. These bankers should put their money where their mouth is, and sell french debt, if Hollande has a 70% probability to win the election. Surely, Hollande said that he considered international finance “the enemy”: but next year, France will have to raise several hundred billion euros to refinance public debt. So finance may be the enemy, but the government needs it. And finance will win.
Of course, Hollande has promised to create a 75% marginal tax rates for income over 1 million euros. And to separate commercial and investment banking. The first reform is mostly symbolic; the second reform is in the line of what is intended by the very pro-market british government. And reality will knock.

It seems that either candidate who wins the election round must choose: in favour or against Euro. People are tired by eurozone trouble, austerity, etc etc. Is there that feeling in France?
The problem with euro is always the same: impossible to leave, very hard to stay. But the anti-euro sentiment does not work in France. Marine Le Pen has lost ground in the polls when she started talking about leaving the euro; now she has changed her discourse to go back to her anti-immigration stance. Nicolas Dupont-Aignan and extremist candidates who want out of the euro are very low in the polls. Even far leftist Melenchon, whose program (if implemented) would mean practically leaving the euro, insists that he wants to stay, only to change the rules.

If you were to be the French finance minister, what would be the first action of your mandate?
This is not an enviable position for years to come! Right now it’s election time, so problems are swept under the carpet. But you can bet that the next minister will be bombarded with alarmist notes from finance administration, asking him to be firm and to reduce spending, because public finances are in dire straits. It is the ritual of intronisation for every new finance minister in France. Hollande said that his finance minister would first make a public audit of french finances.
My favorite economic reforms would be: replacing present labor market regulation system (in which courts decide if layoffs are legal) by a fixed tax on layoffs, as was suggested by economists Olivier Blanchard and Jean Tirole in 2003. A complete restructuring of the Paris area, a fusion between the capital and neighbouring cities, to allow for more housing construction: Paris is quickly becoming Venice, with an average price of 8000 € / square meter. And relaxation of immigration laws, especially from central europe, to fix labor shortages in some low-wage sectors (for instance, agriculture). The probability for such reforms to happen is precisely, zero.

Try to think Eurozone in 2015. What is your perspective?
Lots of uncertainty on this one. For 2012, I think the eurozone will do what it does best: muddling through, kick the can down the road. The Ecb will maintain banking systems in artificial survival. Europeans are buying time, but this time should be used to make long-term plans for public finances (instead of nobrain, immediate fiscal austerity) and reform to boost growth. This is definitely not happening. I must say that I am very pessimistic over the long term. If growth does not come back, mindless austerity in already depressed economies will raise public anger. And creates already a huge lot of suffering.
The optimistic scenario is the following: after trying everything that does not work, european leaders finally, in every country, do what is necessary to rebalance current accounts and raise growth. But the italian example is not a source of optimism: vested interests strike back and make economic reforms empty.
So I think the eurozone will stay another long time in life support, with the Ecb as the only, and reluctant, savior. A long time of low growth, high unemployment. Japanese lost decade, and this seems to me the more likely scenario right now.