The elections of this week-end are widely interpreted as a strong signal by voters that they are unhappy with austerity or what they perceive to be austerity. Will the elections change the speed of budget consolidations? Will France even reverse policies? Or will the elections not lead to any change?
In Greece, it appears highly unlikely that elections will change the current policies. De facto, even if there was to be a new election due to the inability to form a government and at the next elections the anti-austerity Syriza party would come to dominate the political scene, there is still little it could change. The Greek adjustment path is largely set by the Troika, i.e. the European Commission, the IMF and the ECB. The Troika will not be willing to renegotiate the agreement. If they were, they would give an election recommendation to all other countries under financial assistance programmes and conditionality would lose its meaning. The Greek election shows the impotence of democracy in a state that has lost sovereignty.
Also in France, the new president will have limited room to completely reverse fiscal policy. Francois Hollande cannot and will not enter on a large scale public spending programme. International investors are typically fiscal conservatives and will immediately react and demand a risk premium. Looking at the French economy, it is also clear that France needs ambitious reforms to become more competitive and more innovative. Already now, it has one of the largest government sectors and its fiscal performance is poor. In fact, France did not balance its budget since 1974. Instead of spending, Hollande will have to do the kind of courageous reforms that the former German chancellor Gerhard Schröder did. This is hardly in line with his election promises. But only a stronger and more vibrant French economy will increase France’s negotiating power in Europe.
But Hollande’s victory will make a big difference on the European scene nevertheless. The German chancellor Angela Merkel will be more alone in her demands. Voters across Europe clearly say that something needs to be done to improve their lives. Merkel cannot ignore these voices and more and more heads of state and government will tell her that something needs to change. Moreover domestically, her aim is to reduce income inequality and make sure that at the next federal election, the left cannot start a social campaign against her. One of Merkel’s closest domestic allies, the labour minister Ursula von der Leyen has therefore already demanded a minimum wage in Germany.
The European signal is clear: European voters ask for more demand and more demand will also be helpful for German domestic politics. The obvious solution to this constellation is to create more demand in Germany. The probably best way to produce demand in Germany is by increasing wages significantly. This is a much more effective mechanism than a short-run fiscal stimulus programme as higher wages will permanently increase income. It is also an effective way of adjusting imbalances in the euro area as German inflation will increase beyond the euro area average allowing other countries’ inflation rates to fall below the average. It is also likely that demand spillovers to other European countries will be stronger for German household income than German public sector spending. In fact, it is well known that public spending is typically targeted on domestically produced goods and has relatively little spill-over effects across borders.
The German finance minister, Wolfgang Schäuble understands the basic symmetry argument and the French elections make this argument even more important politically. He has therefore said clearly to the German wage negotiating parties that higher wage growth is absolutely warranted. The ongoing wage negotiations against the background of record low unemployment provide some evidence that wages in some key sectors of Germany may grow by 4% or more. This would imply some extra inflation in Germany beyond the two percent euro area average. In that sense, the election in France may make a big difference for Europe. It is not so much that France will be able to reverse its own policy course. But France will send the right message to Germany and Germany may change course.
A rebalancing of the euro area requires a shift of demand from Southern Europe to Germany. To date, demand in Southern Europe has dropped significantly with the strong deleveraging process ongoing in the household and corporate sector. This is a necessary and unavoidable process resulting from the overly high debt levels in the corporate, household and/or government sectors. Large fiscal deficits in some countries have been used to dampen the effect of the deleveraging on overall demand. However, large deficits will prove unsustainable and will have to be reduced eventually. The current debate about austerity versus growth is largely about the question of the best speed of fiscal consolidation in the South.
At the same time, to avoid a recession in the eurozone, more demand will need to be produced in countries of the North. The currently weak growth of the eurozone as a whole shows that insufficient demand in Germany has been created. The best way to create more demand will be by increasing German wages on the back of a strong boom in Germany. Ultimately the rebalancing will have to come from a change in relative wages with wages growing below the average in the South and above the average in Germany. This is the real challenge Europe faces and the elections may make this happen by forcing German politics to change course on wages. Resisting wage growth and a credit boom in Germany would be a mistake. The German political system has started to understand that resisting symmetric adjustment will prove costly for Germany.