In my recent piece from the Financial Times (paid content), I argue that the German economic model being sold so aggressively throughout the euro zone may not be the most effective policy for Europe’s lagging economies. The mere fact that some Germans still debate its benefits should raise a red flag for those European countries now following suit.
In a push to overhaul Europe’s lagging economies, the German government has tried to sell fiscal rectitude and a sped up version of its own reforms as a model to emulate. Many Europeans have opted to follow Berlin’s example. For instance, former Italian Prime Minister Mario Monti has introduced a pension reform that almost mirrors the German system. He also tried to introduce German inspired labor market reforms.
Against this backdrop, it is not surprising that despite a two month long inability to form a government, senior German government officials remained steadfast in their confidence that the main Italian political parties would eventually forge a compromise and stick to German inspired economic policies. Indeed, after much political wrangling, Italians started doing exactly what Berlin wanted them to do all along: they forged a grand coalition. The inaugural speech of Italy’s new Prime Minister Enrico Letta offered even more reassurances. He presented a laundry list of promises suggesting that Italy has had it with austerity and would soon tell Berlin enough is enough. However, Letta’s core message was one of continuity. He promised he would not ignore common European fiscal rules. Despite his planned tax reductions, including the much-hated home property tax, Letta said his budget deficit would stay below the European mandated 3%. Berlin should feel pretty confident that, at least for now, the new government will stick to Monti’s course.
What is causing true headaches in Berlin as of late is the situation in France. Paris is the last European bastion obstructing the spread of a German styled overhaul of the euro zone’s economies. In fact, French resistance to rein in public spending, along with its timid approach in initiating structural changes in the pension system and in its rigid labor market, could soon tempt other European nations currently applying ‘growth friendly consolidation’ to slow down their own process of adjustment, thereby isolating Chancellor Angela Merkel in her push to quickly apply the German cure to an ailing continent. Indeed, the so-called austerity versus growth debate could soon reach a tipping point
French President Francois Hollande should not back down. Attempting to repackage Germany’s actions from a decade ago into a remedy for France in a short period of time is no guarantee for success. In fact, it could prove to be a recipe for disaster. Combining fiscal austerity and structural reforms is hard under any circumstances. In the present environment, it could prove self-defeating.
This is not to argue that fiscal responsibility or reforms are wrong. Structural adjustments are necessary when economies loose competitiveness. But doing things properly matters. If the French government decided to act with boldness now, the short-term effect would be recessionary. That would delay the recovery of the rest of the continent. Germany simply cannot afford for France to slip into the same kind of turmoil that countries such as Italy are experiencing. Berlin would not be able to help, even if it wanted to.