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martedì 7 gennaio 2014
QED n. 27: What? France? Yes. France.
On May 6, 2012 I published on this blog a post (in Italian, my favourite language: apologies for this outmoded home bias), commenting on François Hollande election. My point was very simple: France was in a bad predicament, not so very dissimilar from the Italian one. It was slipping slowly but inexorably from a current account surplus to a current account deficit, i.e., from being a net external creditor to being a net external debtor, just as Italy was doing.
This was my graph at that time:
Here is a revised and updated version:
The graph is updated, because in the meantime we have had three other releases of the WEO. It has also been revised because in the previous graph I reported the sectorial balances as sectorial deficits (using the convention adopted for instance by Giancarlo Gandolfo – see the first row of his flow of funds matrix, Table 6.1 in his textbook). In this revised version, I report the sectorial balances as balances: a positive sign indicates a surplus, a negative sign indicates a deficit. The latter convention is now widespread, and for this reason I decided to invert all the signs in the graph.
A few remarks. France expansionary fiscal policy in 2009, in response to the Lehman shock, is shown in the first graph as an increase in government deficit (the broken line F), in the second graph as a decrease (worsening) of government budget (the blue line T-G). The inexorable worsening of France’s external indebtedness comes out in the first graph as a steady fall of the current account balance (the dotted line CA), and in the second one as a steady increase of net capital imports (the red line M-X). Last but not least, in the second graph I have marked as dotted lines the IMF (rosy) forecasts of the three balances.
What was my point in May 2012?
A very simple one. Since its entry in the Eurozone France, like Italy, or Finland, or Spain, had experienced a steady worsening of its net external lending, and since 2005 it had become a current account deficit country (i.e., a net foreign capital importer). For that reason, France would have been forced to put into practice an austerity policy.Why? Because in the absence of the re-equilibrating mechanism provided by exchange rate flexibility, austerity is the only instrument a government has in order to reduce its external deficit. If the nominal exchange rate does not respond to external imbalances, you need to engineer some unemployment, in order to reduce wages, thereby fostering exports, and cutting imports (as a consequence of the fall in income). As simple as that.
From that sad economic truth I drew three political conclusions.
The first one was that Hollande’s election was no surprise. As I had many times remarked (starting in August 2011), each time an adjustment of the external accounts called for “social butchery” (this is how we call in Italy the neoliberal policies against social and economic rights), the European elites had chosen a butcher with a red apron, for the simple and good reason that blood stains stand out on red less vividly than on white (the colour of the former Christian-Democrats) or blue (the colour of the “right-wing” Berlusconi party). Explanation: in all evidence, anti-labour policies seem to be much more acceptable to workers if they are proposed by “left-wings” politicians. This is what happened in Germany with comrade Schröder and his Hartz reforms, this is what happened in Italy for thirty years, where we witnessed the ultimate dismantling of wage indexation by comrade Amato, the labour market reform by comrade Treu, the introduction of the euro (with the related “austerity” policies) by comrade Prodi, and so on.
The second conclusion was that Hollande would have a very difficult life. Inverting the more than decennial trend in France’s current account would prove very difficult, in the light of the accumulated competitiveness gap with Germany, especially in times of global recession (where you cannot rely on external demand to sustain your exports). This would have accelerated the rise of Marine Le Pen, that I had foreseen in 2011 (and many others even earlier, I suppose). In other words, Hollande would at any rate have been forced to deceive his constituency, eventually leading France into a situation of political instability and social trouble (even before the next presidential elections).
The third political conclusion was less trivial. Guess who was France’s creditor?
Yes, of course, you knew very well! (and here is the source).
From this simple accounting fact, a twofold conclusion could be drawn.
First: that every time the Franco-German axis was mentioned, the appropriate response would be a laugh (or a yawn). In the history of mankind there are no examples of an axis between a creditor and a debtor, for the simple reason that creditors and debtors have (legitimately) conflicting interests. Debtors like inflation, creditors dislike it. Deflation’s beauty is in the eyes of the bond holder. Of course you know that Europe is caught in an unprecedented deflation because it is ruled by a large creditor: Germany. Oh, didn’t you notice that? I apologise for having to wake you up. Better late than never...
The reverse of the coin was that any hope that Hollande would go to Germany, bang his fist on the table and force Angela Merkel to adopt a more reasonable (i.e., less deflationary) policy was simply ridiculous. Capitalism is a strange thing. The debtor has actually a lot of bargaining power (as some recent studies demonstrate; here Granville and Nagly, 2013). As the old saying goes: “If I owe you a pound, I have a problem; but if I owe you a million, the problem is yours.”
However, every technical problem has a political solution. Much in the same way as Mario Monti was in Italy, François Hollande in France was a liquidator of his country’s external debt, and in order to accomplish this task on behalf of Germany he would have had to “destroy internal demand” in his country (as Mario Monti very aptly put it here).
There was no hope that comrade Hollande would come to the rescue of the poor Southern countries, no hope that a sense of Latin solidarity, or simply of economic rationality, would push him to fight against Germany’s irrational policies. No hope. Nobody could rescue the Italian, Spanish, Greek, Portuguese citizens, but themselves.
Needless to say, I was attacked in my country by left-wing (?) heterodox (?) economists (?) because my blasphemy had reached the point that I doubted comrade Hollande’s willingness and ability to rescue the European proletarians. Well, to be honest, my blasphemy was two-fold: not only the Italian “critic” economists had pinned a lot of hopes on Hollande, but also... hem...
And apparently I was right (which unfortunately means that the others were wrong).
Well, to be honest (not humble: honest), it was not me: national accounting was right. It has close affinities with arithmetic, something which is really difficult (although not impossible) to suit to one’s prejudices. The bare logic of sectorial balances was enough to predict what is now happening. Late forecasts came from the Economist (in November 2012), and the awareness that France is the largest “sick man” (actually: woman) of Europe, and that Hollande is not willing nor able to do something about that, is now (January 2014) widespread. Too late, not only for France, but also for the other peripheral countries, that have lost a lot of time deluding themselves with their vain hopes in comrade François.
I can hardly be considered as a friend (or a servant, as someone graciously defined me) of rating agencies. However, I must disagree with Krugman’s view that the S&P downgrade of France is purely “ideological”. This makes little sense. I mean: of course rating agencies are ideological! This is not such a big discovery. One just needs to remember the Lehman case. But
(1) it makes little or no sense to depict Hollande as a defender of widows and orphans, and
(2) France has worse fundamentals than the UK and a much worse economic outlook.
As for (1), just have a look at what Hollande is doing. After fighting Sarkozy’s proposal to increase VAT in order to finance a reduction in the tax wedge, he is now applying exactly this policy, blamed as “supply-side socialism” by the Front de gauche (each North is a South of another North, and each left-wing has something to its left...). Now, VAT is a regressive tax, and it was already increased at least twice (French VAT is a very complicated thing, one could write a novel on it: In search of lost rates). The purely demagogical 75% rate on the “high incomes”, instead, had a very difficult life and is supposed to come into force only in 2014. The widows and the orphans are not better off, most of them will not vote socialist anymore, and this was foreseeable (and foreseen by at least one economist). As a matter of fact, on top of all this one should consider that although there may be more or less harmful, more or less equitable, ways to perform austerity during a recession, austerity in a recession is mostly wrong, and the very reason why France (and Italy, and Greece, and Portugal, and...) is practicing austerity policies during a recession is that they lack a powerful equilibrating mechanism: exchange rate flexibility. But Hollande (like Letta, Rajoy, Papademos, and so on) seems not to understand that sooner or later he will have to reckon with this fact. Therefore, in my humble opinion, Krugman’s enthusiasm for comrade Hollande seems (and seemed) a bit misplaced, at least until now. I have proved that I am not saying that with the benefit of hindsight.
As for (2), have a look at UK sectorial balances:
You may not see such a big difference from those of France, at first sight. For instance, the UK reacted to the 2008 shock by increasing its public deficit, just as France did (this shows up as a sudden drop in the blue T-G line). But, have a look at the red line, at external indebtedness. True, the UK is in a structural current account deficit position, i.e., it is a net foreign capital importer (the red line is above zero). Is that a big problem? Well, not at all, for two reasons, one “structural”, and another “dynamic” (in the economic sense). Firstly, because the UK has one of the most developed financial markets around the world. The UK’s structural current account deficit reflects the willingness of foreign citizens to invest in pound-denominated assets (a willingness that rose, for obvious reasons, during the Eurozone crisis). Each time you buy a pound-denominated asset issued by a UK-resident agent, the UK imports foreign capital (well, if you are not an UK resident unit, of course). There are no particular reasons to assume that this will lead to an unsustainable net financial asset position, to the extent that the UK will continue to look like a much safer haven for international savings than the Eurozone! Secondly, since the inception of the euro France’s external balance deteriorated (France became a net importer of foreign capital, starting from a net exporter position), while the UK one was stable. And very often in economics the pattern of variables matters much more than their level. This pattern reveals that France is importing foreign capital for very different reasons than the UK: not as the result of its leading position in the international financial markets, but as the result of its deteriorating competitiveness in the “euro age”.
Yes, you know it: the UK did not enter the euro. France did, and in all evidence it could not afford it. The red line in France’s sectorial balance graph reveals this simple truth.
Messrs Hollande, Barroso, Rehn (and many others) may very well ignore it, but what is economically unsustainable eventually proves to be historically unsustainable. May God etc.
Meanwhile, Mme Le Pen will reap the fruit of having said some trivial economic truths. Yes, she mixed them up with a lot of questionable things, I know. I am not happy at all with this outcome, and I have done my best to warn the politicians against it (at least in my country). But their stomachs were never empty, and for that reason it proved really difficult to make them understand that when hunger bites, everything else becomes a detail.
So sad, so true.
Repeat after me: there will never be a Franco-German axis. And if you do not believe me, believe them!
This is Germany:
and this is France:
Not very similar indeed, but you should consider this as a richness, not as something to level out.
By the way, the harpsichord is Italian, and the harpsichordist as well. Europe has never coincided, and will never coincide, with the euro.
(with many thanks to Patrick Lynch and Elena Marini...)