France and the Commission

The platform I use for this blog gives my ‘pageviews by country’. One surprise is that, using this criteria, the country which comes third in the list, after the US and UK respectively, is France. (Over the last month, for example, about 12,000 pageviews compared to about 36,000 in the UK and around double that in the US, with a whole group of countries below France at around 5,000.) This is really nice, particularly as I have only once written a post specifically about France, over a year and a half ago.

So a recent post by Ronald Janssen in the Social Europe Journal allows me to make up for that. First some background if you do not live there. France is subject to the Fiscal Compact’s 3% budget deficit target like everyone else in the Eurozone.  European Commissioner Olli Rehn is the chief enforcer of these rules. In May the Commission granted France, along with a few other countries, 2 years grace before they needed to achieve that target. The Netherlands was given only one year, with consequences I talked about most recently here.

The chart below shows OECD numbers and forecasts for various fiscal measures in France. The financial balance relates to the 3% target. The underlying balance essentially cyclically adjusts this. As you can see, the key reason that France is not meeting the 3% target is depressed output. The OECD estimates the output gap in 2013 will be nearly -4%, rising in magnitude to -4.5% in 2014. The underlying primary balance is the best indicator of what government policy is doing: fiscal policy has been tightening ever since a sharp expansion following the 2008/9 recession.

  

So far, so typical of the Eurozone and elsewhere. However what makes France relatively unusual is the pattern of this tightening. As the IMF clearly showed in analysis I discussed here, it has achieved this fiscal contraction entirely through tax increases rather than spending cuts. The first best thing to do, of course, is to delay fiscal tightening until the output gap has closed. The Eurozone’s fiscal rules will not allow that, and instead in the current context encourage pro-cyclical fiscal policy. I have never met a macroeconomist who advocated pro-cyclical fiscal policy, but of course those behind the Fiscal Compact know best.

If you have to follow the Fiscal Compact, then I have always argued from the point of view of doing least damage to the economy in a recession any temporary fiscal tightening should focus more on tax increases than spending cuts. You might, for example, try to meet the Fiscal Compact rules in the short term through temporary tax hikes, and follow with more permanent spending cuts and/or tax increases once the economy recovers. To a first approximation that appears to be what the left wing government in France is trying to do (most notoriously by temporary increases in the top tax rate).

My argument has always been based on straightforward macroeconomic theory, but as Ronald Janssen points out in his post, this is fully supported by recent IMF empirical work. It is therefore entirely predictable that European Commissioner Olli Rehn should take completely the opposite point of view. He is quoted as saying that new taxes would “destroy growth and handicap the creation of jobs." “Budgetary discipline must come from a reduction in public spending and not from new taxes,” he added.

Now I'm not sure whether that counts as advice or instruction: within the Eurozone it is increasingly difficult to tell. I suppose you could argue that Rehn’s concern is more about the longer term size of the French state, and that his obvious belief that the French state is too big comes purely from worries about the implications for macroeconomic performance. But what struck me was simply this. In the election of April 2012 the French people elected a left wing government that had a clear platform of achieving fiscal consolidation partly through tax increases. Even if the Commissioner thinks that is a foolish thing to do, that is their choice.

It is one thing to have a set of fiscal rules that focus on overall budget deficits: however misguided those rules may be, the French government did agree to them. What I do not think any Eurozone government signed up to was having the Commission tell them what the size of their own state should be. With these remarks, together with its insistence that various Eurozone countries undertake certain ‘reforms’, the Commission appears to be doing its best to create a de facto fiscal union. The only problem, of course, is that the French did not elect Olli Rehn.