Sarkozy's economics is not working
The oncoming recession is about to test an economic proposition that has enjoyed immense popularity in France. According to this proposition, a government can, and should, accept a trade-off between fiscal prudence and economic reform. Having fully bought into this scheme, Nicolas Sarkozy, the French president, has set out to reform the supply side of the economy, but he has left the budget deficit mostly untouched. This strategy is now coming unstuck.
Mr Sarkozy has already postponed the goal of a balanced budget until 2012, two years after an agreed date set by eurozone finance ministers. Even this remote and never quite credible date looks unrealistic now. On the present trajectory, France will not achieve a structurally balanced budget until at least 2014.
The supposed advantages of prioritising supply-side reforms over deficit cutting, derives from a simple consideration of political economy. Most economic reforms run into political opposition from those who stand to lose. If you consolidate the budget at the same time, you create even more losers and the opposition to reform becomes overpowering. A temporary increase in the deficit may be a price worth paying if this buys you some decent economic reforms. So goes the theory.
So then, how good are those reforms? I suspect that the overall impact is positive, but probably not nearly as much as Mr Sarkozy’s acolytes suggest. He did manage the considerable feat of co-opting trade unions and employers into reasonably ambitious labour market reforms to produce more flexibility and longer working hours. Mr Sarkozy has turned out to be a consensus-seeking reformer, and that is probably not a bad thing either.
But there is a price to be paid for his trade off between reform and fiscal discipline. There are three big downsides. First, and most important, is the loss of room for fiscal manoeuvre to counteract a sharp downturn. Fiscal policy is the single most important instrument with which a government in a monetary union can control the economic cycle. If you leave yourself no room for manoeuvre, your ability to confront economic shocks is constrained.
The most important provision of the stability and growth pact is the requirement that countries should run a balanced budget over the economic cycle. When the downturn comes, there should be sufficient room for manoeuvre to allow the deficit to increase. Spain and Germany are in that position now. Both countries can now let the fiscal stabilisers do some of the heavy lifting of adjustment. As the economy weakens, tax revenues are falling, social spending increases, and the government simply can sit back and allow the deficit to rise with impunity.
The French deficit is already set to rise to close to 3 per cent of gross domestic product this year, the ceiling imposed by the Maastricht treaty. It may breach that level next year, depending on which growth projection you believe. This means that France is not in a position to benefit from the fiscal stabilisers and to comply with the fiscal rules at the same time. Mr Sarkozy will have to make a choice.
If he chooses to comply with the rules, he would run a pro-cyclical fiscal policy and cause damage to the French economy. If he chooses to flout the rules, as he probably will, he would confront the second important shortcoming of his approach, which is a loss of political influence. Just witness the futile attempt by Christine Lagarde, the French economy minister, to persuade her European colleagues at an informal get-together in Nice over the weekend of the virtues of economic policy co-ordination. When it comes to economic policy in Europe, Mr Sarkozy has insufficient allies among eurozone members. You cannot lead the eurozone and break its most important set of rules at the same time. France has manoeuvred itself into a corner. The louder Mr Sarkozy bashes the European Central Bank, the worse his isolation gets. I find this a great shame. I actually like some of the French ideas in terms of banking supervision or global financial regulation. But the French position on these issues cannot prevail as long as Mr Sarkozy breaks the rules.
The third flaw is more fundamental. Pitching economic reform against fiscal discipline constitutes a category error, a false trade-off, because the budget deficit is in itself a structural weakness. France still has a largely unreformed public sector. A good deficit-reduction plan would go a long way towards reforming the economy as it forces government to define what the public sector should, and should not do and how to pay for it.
Mr Sarkozy’s trade-off between reforms and fiscal discipline are not universally accepted by everybody in the French establishment. A notable intervention came recently from Jean Peyrelevade, a former president of Crédit Lyonnais and a senior government official in the early Mitterrand years. Mr Peyrelevade launched a blistering attack on Mr Sarkozy in Le Monde, accusing the president of repeating exactly the same mistakes as François Mitterrand during 1981-1983, when increases in public spending caused economic instability. The comparison is not entirely justified, since Mr Sarkozy is at least addressing some of the country’s deep structural problems. But I suspect that Mr Peyrelevade is more right than he is wrong. When you undertake micro-reforms, you ignore macroeconomics at your peril. Negligence of budgetary consolidation is the deadly flaw in Mr Sarkozy’s economic strategy.
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