DeansTalk

Let’s hope Hollande was lying to get elected
by INSEAD Finance Professor Theo Vermaelen

François Hollande has promised to promote growth by increasing government spending such as hiring 60,000 more “fonctionnaires” and creating 150,000 government subsided jobs for young people. He will increase the minimum wage, shorten the retirement age and increase taxes, including essentially confiscating salaries above 1 million euros and punishing the “enemy” (increase taxes on the financial sector). He also will not sign the European fiscal treaty without a commitment to spend more European tax payers’ money. In my opinion this spells disaster for France as well as for Europe. France and Europe need the opposite strategy: reducing government spending and encouraging growth through the private sector by lowering taxes and social charges, as well as introducing labour market reforms to introduce labour market flexibility including the possibility to fire government bureaucrats.

The election also sends a disturbing message to politicians all over Europe: if you endorse fiscal responsibility and attack the European Social Model, you are likely to lose your job. Restructuring government finances, which essentially means creating short-term pain in order to promote long-term gain, is not obvious in a democracy. Too many people are addicted to the “free” lunches handed out by the massive growth of government witnessed during the last 50 years.

Financial Market Impact
If the much-hated financial market believes that Hollande is serious, French interest rates will rise, and the deficit will increase. Ambitious people will refrain from investing and working in a country hostile to income inequality (inevitable consequence and driver of economic success) and as a result unemployment will rise as well. It is unlikely that Europe and the euro can survive another economic basket case after the PIGS (economies of Portugal, Italy, Greece and Spain). Some of my more optimistic colleagues argue that when Hollande witnesses the failures of his policies, he will make a U-turn as Mitterrand did in the early 1980s. But I am afraid this will be too little too late. In 1980 the French government debt was 20 percent of GDP, while today it is 80 percent. What is more likely is that economic chaos will encourage the growth and influence of more extremist political parties, both on the right and the left, with unpredictable consequences.

Of course my pessimism is based on the assumption that Hollande will do what he said he will do. I am still hoping that he was simply lying to get elected.
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Plus Ca Change…
by INSEAD Economics Professor Antonio Fatas

From an economic point of view, the French election will probably not create much change. Some of François Hollande’s economic ideas are different from those of Sarkozy but not that different.

It is true that his election will add to the strength of the argument that austerity is not the way out for Europe (or the world). But he is not alone. The European Commission just admitted that they will be lenient when judging budget deficits given economic conditions; the IMF is advocating for being more pro-growth given the circumstances... so Hollande will be one more voice in that direction. As an economist, I think this is good for Europe and the world economy that we question the model that says that coordinated austerity is the solution - it is not!

Budgets and Taxes
Regarding the budget, Hollande has promised increased spending in some areas (education) and higher taxes for those with very high incomes. While some of his ideas might seem radical to many, we need to put them in perspective. His proposal to tax income above 1 million euros at a rate of 75 percent might sound completely out of touch with reality - but we have seen similar or even higher marginal tax rates in other countries before (Sweden or even the U.S. during the 1960s) with limited impact on growth. France today has a significantly lower marginal tax rate than a country like the U.K. (that recently raised the top marginal tax rate by about 10 percentage points). Having said that, he will face strong opposition and resistance and it is likely that he will not go as fast as he said he would. The reality of government budgets is one of continuous negotiation and juggling among the pressures of so many different groups.
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A Matter of Degree
by INSEAD Political Science Professor Douglas Webber

Don’t expect any fundamental changes in the nature and direction of French government policy, including European policy; instead, look for some differences of emphasis and degree.

François Hollande is bound by his election promises to push hard for changes (or additions to) the EU fiscal treaty. Over the last few weeks and months, an ever wider consensus has begun to develop to the effect that a fiscal policy of austerity alone will not solve the euro crisis. Most of the governments in southern Europe will welcome a stronger “growth” component in the treaty (or, for example, in a protocol attached to the treaty). Similar noises have been made in the last few days and weeks by the chairman of the ECB and the European Commissioner in charge of economic and monetary affairs. The German Social Democrats, who are likely to join the federal government after elections in September 2013, are pretty much on the same wave-length. I therefore expect Hollande and Merkel to reach some kind of compromise on this issue. Otherwise, as both leaders – and, for the most part, their respective parties - are basically pro-European, they are likely, despite likely initial frictions, to work together closely and quite well. They may actually reach a modus vivendi more quickly than Sarkozy and Merkel did. Their initial relations were very difficult and they never got on very well at a personal level.

Hollande vs Sarkozy
Hollande’s election platform in respect of fiscal policy differed from Sarkozy’s only by proposing that the French budget be balanced over a period of five rather than four years, that the deficit be reduced more by increasing taxation than public spending, and increasing taxation on very high income-earners. His biggest challenge will arise if and when economic growth is slower than anticipated and his government is forced either to increase taxation or cut spending more radically than his platform proposed. Given the renaissance of the radical Left in France (as shown by the quite high vote for Jean-Luc Mélenchon in the first round of the elections), he and his government may then find themselves torn in diametrically opposed directions by the international financial markets, on the one hand, and an important segment of his majority and the trade union movement, on the other. “Structural” reforms, such as those aimed at liberalising the labour market and making it easier for firms to hire and fire employees, will be politically well-nigh impossible.

First of all, of course, Hollande has to ensure that the Socialist Party and its allies win a majority in the Parliamentary elections in June. He will take some popular, largely “symbolic” decisions (such as cutting his and government ministers’ salaries) in the next few days and weeks to maximise the likelihood of this outcome. The Left would then control not only the presidency and both chambers of parliament, but also most French regions and most large cities, making it stronger in terms of the occupation of public office than it has been at any other point in French political history.

However, if the Eurozone crisis continues or, worse, deepens, Hollande’s honeymoon as president is likely to prove very short and the Left’s stranglehold on French politics ephemeral. If, after Sarkozy and the traditional Right, Hollande and the Socialists should also fail, the extreme right-wing National Front and its leader Marine Le Pen may emerge a lot stronger from elections in 2017 than they are already today. Then yesterday’s and next month’s elections will look in retrospect like a curtain-raiser to the main event, which would involve a fundamental transformation of the French – and with it, the European - political landscape.
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Antonio Fatas is Professor of Economics and the Portuguese Council Chaired Professor of European Studies. Theo Vermaelen is Professor of Finance and the Schroders Chaired Professor of International Finance and Asset Management. He is the Programme Director for Corporate Financial Strategy in Global Markets and Co-Director for Global Investors Workshop, part of INSEAD’s portfolio of executive education programmes. Douglas Webber is Professor of Political Science.