Sarkozy's plans for the euro area are bad economic governance

By: Wolfgang Münchau

Many good ideas in politics have failed because the wrong people have proposed them for the wrong reasons. One such idea that has accompanied the political economy debate ever since the launch of the euro is what the French call gouvernement économique – otherwise known as economic policy co-ordination. The latest proponent of this idea is Nicolas Sarkozy, the newly elected French president, who during his first presidential visit to Brussels last week threatened to make some concrete proposals later this year.

He did not say what these proposals would contain but, judging from his repeated references to the strong euro, during the election campaign and again last week, it is not difficult to guess what he has in mind: a mechanism that gives politicians a greater influence over the euro’s exchange rate. French newspapers also speculated that he would try some other ideas, such as harmonising corporate taxes or imposing what the French call a “social VAT” – an increase in value added taxes to help fund social programmes.

 

There is good and bad economic governance – and Mr Sarkozy’s proposals are overwhelmingly of the bad variety. Everything he said about European economic policy can be neatly classified into two categories. It is either inflationary or protectionist. They are the kind of proposals that give policy co-ordination a bad name.

So what constitutes good co-ordination? I can think of three examples. The first would be to give the eurozone its proper representation in international organisations. Why should France, Germany and Italy be pulling separate strings in organisations such as the International Monetary Fund or even the Group of Seven/Eight leading industrialised nations? The answer is that they still try to maximise national power and the last thing Mr Sarkozy will ever do is to reduce French influence in the IMF for the sake of the eurozone.

The second area is banking supervision. The case for a eurozone-wide banking regulator is overwhelming, especially at a time when the number of cross-European banking mergers is rising.

The third area is co-ordination of structural reforms. This is a contentious issue, but I do not have the slightest doubt that the eurozone would be better off if Germany focused on financial reform, Italy on the public sector and France on the labour markets.

What about fiscal policy? The stability and growth pact is clearly not an optimal fiscal regime, but it has worked better since its revision in 2005.

In most countries, though not in France, the deficits have been coming down fast. Last week, Mr Sarkozy threatened a “fiscal shock”, which could trigger a serious conflict with the rest of the eurozone. On this score, I would expect less “gouvernement économique” in the future, not more.

What about exchange rate co-ordination? The answer is it depends what you want to achieve. If you are talking about occasional tactical intervention, then there is no harm in closer co-ordination. The European Central Bank rarely intervenes in the foreign exchange markets. In the few cases when it did in the past it was mainly to calm frenzied speculation.

In most countries, exchange rate policy is the responsibility of the finance ministry. In the eurozone, the legal situation is ambiguous. But I doubt that this is what Mr Sarkozy has in mind.

I also doubt that Mr Sarkozy will propose a formal exchange rate regime – for example fixed bands, or target zones. There would be no majority for this. It would be more politically astute to opt for an intermediate strategy, for example some form of managed floating – something more than tactical intervention but less than a full-blown exchange rate regime.

The ECB would no doubt reject such a proposal and argue that such a policy would be inconsistent with its price stability objective.

Occasional intervention would be much less of a problem, since a central bank can always sterilise open market operations, or it can use currency swaps to influence the exchange rate without much impact on the money supply. But a policy that requires a central bank to intervene persistently is bound to drive up the rate of inflation eventually.

There is a chance, albeit a slim chance, that Mr Sarkozy will get away with this. The actual politics will, of course, depend in part on the level of the exchange rate. My hunch is that Germany would probably not accept any of this today, but the German position might change during an economic downturn, or if the euro/ dollar exchange rate were to rise above a certain threshold – say $1.40 per euro. But I would be surprised if Angela Merkel, German chancellor, were keen to co-operate on this issue.

It is also possible Mr Sarkozy will content himself with a more modest set of proposals such as upgrading the status of the eurogroup, the finance ministers of the eurozone countries. But if he really were to do a fraction of what he threatened during the election campaign and more recently, he would probably create a big political crisis in the eurozone by opening up old wounds. My guess is that Mr Sarkozy will have a go at this, but ultimately he will fail. In the meantime, the benevolent forms of co-ordination will have to wait until Europe’s politicians get serious.

 

© The Financial Times

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