06 May 2012

D Day in French Elections

The second round of French presidential elections are underway as I write this.

The last opinion polls conducted before the legal deadline found that the incumbent Nicolas Sarkozy might lose and his challenger Fran├žois Hollande could be president tomorrow morning.

If you are a regular reader of this humble soap box, you already know that I am not as certain about Sarkozy's early demise. In the last few days the gap between the two candidates narrowed considerably and I am guessing by now (no polls were conducted since Thursday) it could be within the statistical error margin.

As you can imagine, I am not interested in the horse race aspect of this. What is of importance to me is the different ripple effects the election of these two candidates would generate.

Currently, the defenders of austerity (also known as the confidence fairy people) have a monopoly on the economic discussion. They claim that the most important thing is to reduce debt through austerity measures because that is the only way a country could restore the confidence of bond markets.

As Krugman put it:
Critics warned from the beginning that austerity in the face of depression would only make that depression worse. But the “austerians” insisted that the reverse would happen. Why? Confidence! “Confidence-inspiring policies will foster and not hamper economic recovery,” declared Jean-Claude Trichet, the former president of the European Central Bank — a claim echoed by Republicans in Congress here. Or as I put it way back when, the idea was that the confidence fairy would come in and reward policy makers for their fiscal virtue. 
After two years of high unemployment and contracting economies and double dip recessions, those waiting for the confidence fairy to appear are disappointed.

But despite dismal results of their policy, the discussion for an alternative solution is still blocked by the "austerians." Merkel, Cameron and the American Congress are still firmly in that camp.

If Hollande wins, the "austerians" will find themselves under a lot of pressure. Already, their chief spokesperson The Economist warned French people about the horrible implications of electing "the rather dangerous Monsieur Hollande."

Merkel will also be in a tough spot. Tellingly, in the last few days, while still fully supporting Sarkozy (and implicitly his economic fear tactics) she started giving small indications about the desirability of growth emphasis. But she refuses to renegotiate the "fiscal compact" if Hollande wins:
Merkel, who had thrown her support behind conservative incumbent Nicolas Sarkozy in the French vote and refused to meet Hollande, firmly rejects the Socialist's suggestion that a "fiscal compact" on budget discipline agreed by 25 EU leaders in December should be renegotiated to include a growth component. 
As I explained many months ago (citing Krugman), there is an intractable fiscal reality behind all these choices: Germany's policy of 1 percent inflation for its economy can be achieved only if there is something like 5 percent deflation in Spain (and Italy and Greece etc). It is a zero-sum game.

If Hollande wins, France, with its chronic deficit, high unemployment and higher than Spain debt, will join these southern countries and it will become very difficult for Germany to hold on to its low inflation and low growth emphasis. The result will either be the break up of Euro or Germany being forced to accept a new tack and higher inflation.

If Sarkozy wins, Germany will continue to work with France against these peripheral economies and France will be able to maintain the illusion that its economy is comparable to that of Germany. Together (with Cameron's help) they are more likely to force everyone to continue to wait for the Godot-like confidence fairy.

That will mean generalized Structural Adjustment conditions for half of Europe.

I will post something separate on what that means.

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