18 December 2011

Wolfgang Münchau: UK will fare better in this Anglo-French spat

Münchau comments in the FT on last week's series of comparative statements between France and the UK, which he says were obviously coordinated, and concludes that a rating downgrade for France and the rest of the eurozone is logical and deserved.

 “...one prefers to be French than British at the moment on the economic level” – François Baroin, French economy minister.

“ ... they should start by downgrading Britain which has more deficits, as much debt, more inflation, less growth than us and where credit is slumping” – Christian Noyer, governor, Bank of France.

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There is an obvious gap between the economic narratives. Eurozone leaders believe they have solved the crisis by agreeing a fiscal compact. It was a definitive decision, taken at the European summit of just over a week ago. There will be no fiscal union, no eurobonds, no European Central Bank bail-out. The adjustment will happen through austerity alone – and it will go on and on. A rule to allow a maximum deficit of 0.5 per cent of gross domestic product will in the long run eliminate most public sector debt. The world’s second-largest economy wants to repay all its debts.

The UK government has been conducting a programme of quite extreme pro-cyclical fiscal austerity as well. But there are two differences. The first is a flexible exchange rate – though this offers diminishing marginal returns when everyone pursues the same policy. The second, and most important, is that Britain has its own central bank. The Bank of England has been conducting a much more aggressive monetary policy than the ECB.

Beggar-thy-neighbour type economic policies have a long tradition in Europe. They can work when you are the only one who pursues them – or when the weight of countries not pursuing them exceeds that of those that do. In that case, the adjustment usually goes along with an improvement in the current account position. Given the size of the eurozone, and the policies of the rest of the world, the scope for an increase in the eurozone’s current account position is relatively small. The failure to take into account the effect of co-ordinated austerity has been the main reason the European authorities misjudged the adjustment dynamics in Greece. They are now making the same mistake on a much grander scale.

France has higher nominal growth, a lower debt-to-GDP ratio and lower long-term interest rates. It is even less for Germany, but Berlin, too, will need to tighten fiscal policy if it wants to meet its own self-imposed constitutional rule to allow a maximum 0.35 per cent deficit-to-GDP ratio average over the economic cycle. So everybody tightens policy.

The real difference between France and the UK is simply that the UK is not trapped. Britain is a sovereign country. France is economically a sub-sovereign zone. That is the simple reason why the eurozone needs a eurobond and a lender of last resort function in the system. With those functions in place, policy errors are less catastrophic.

Mr Baroin is therefore quite wrong. You do not want to be French, German or Italian if you have a choice. A rating downgrade for France and the rest of the eurozone is thus logical and deserved.

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