How Hollande Should Handle Merkel

By Charles Grant

The election of François Hollande as French president has excited some of those who blame Germany's emphasis on fiscal austerity for many of the eurozone's ills. Hollande has promised to refocus EU policies on growth and employment. Countries such as Greece, Portugal, Spain and Italy - their recessions aggravated by the EU's insistence that they shrink their budget deficits - would welcome a new approach. Even Marios Draghi and Monti, respectively president of the European Central Bank and prime minister of Italy, and both economically conservative, have called for growth initiatives. But can Hollande - as he prepares for his first ever meeting with Chancellor Angela Merkel - really make a difference? He might, but only if he handles Merkel with great diplomatic dexterity.

Many commentators have interpreted Hollande's victory on May 6th, alongside the defeat of the established parties in Greece on the same day, as part of a Europe-wide revolt against austerity. However, France has not yet experienced painful austerity. And Hollande has promised to match President Nicolas Sarkozy's target of bringing the budget deficit down to 3 per cent of GDP next year, and also to balance the budget by 2017, a year later than Sarkozy had promised.

Opinion polls showed that more voters trusted Sarkozy than Hollande on economic policy, but the election was about much more than economics. Many French people felt strong antipathy towards Sarkozy's character and what they considered to be his un-presidential and undignified style. He also lost because the right is badly divided. There is a natural right-wing majority in France - which is why in the first round of voting the right won more than half the votes. The centre-right Gaullists always find it difficult to deal with the far-right National Front, but this year that difficulty was compounded by Marine Le Pen's success in rebranding her party as more moderate than it was in her father's day. This enabled her to win 18 per cent in the first round of voting. Le Pen's refusal to endorse Sarkozy for the second round meant that only half of her voters switched to him.

However, Hollande did campaign on a policy of 'renegotiating' the EU's recently-agreed and German-driven fiscal compact - which seeks to impose budgetary discipline - to take account of the need for jobs and growth. In most EU capitals, including Berlin, politicians are now calling for an EU 'growth strategy'. German officials met Hollande's advisers before the presidential election and told them that Merkel would not reopen the fiscal compact. But they said that Germany could support some of Hollande's ideas - including enlarging the European Investment Bank's capital base by €10 billion, targeting unspent EU structural funds on infrastructure and introducing a financial transaction tax (FTT). The Germans are divided on whether to back Hollande's idea for EU 'project bonds' (the European Commission is already working on a scheme to boost infrastructure investment with such bonds). But none of these initiatives would increase economic growth significantly - and not even its advocates claim that an FTT would create jobs.

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Hollande's prescriptions for the European Central Bank - that its mandate should not focus only on inflation, and that it should lend directly to governments - are unacceptable to Berlin. Another difficulty for Hollande is that the Germans - and many others, including the two Marios - think a growth strategy must include structural reforms that would boost productivity and thus competitiveness, even though such reforms seldom deliver growth immediately. Hollande appears to be as allergic to structural reform as most of his compatriots. His election speeches called for growth to be boosted through public spending on infrastructure and through investment in new technologies - and explicitly ruled out deregulation and liberalisation. He seems oblivious to the fact that France's very high non-wage costs of employment are one cause of relatively high unemployment (10 per cent, against 6.8 per cent in Germany).

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Charles Grant is director of the Centre for European Reform.

(AP Photo)

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