Tuesday , 21 May 2019

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Macron thinks the EU is not viable without radical reform. His priority is to reshape the eurozone, but Germany is blocking his bolder ideas. He risks isolation in Europe, which could weaken him at home.

In a series of speeches during his first year as French president, Emmanuel Macron has not only sought to define grand concepts like ‘European sovereignty’ and ‘a Europe which protects’, but also proposed dozens of specific initiatives, ranging from an innovation agency, to a carbon tax, to an intervention force. He has taken a special interest in the eurozone, which he believes is unsustainable in the long term without much more federal governance. Macron has had a clear plan for achieving that goal. First, reform the French economy, to regain credibility with Berlin; during the presidency of François Hollande, France’s weakness made the Franco-German relationship unbalanced. Then, persuade Germany and the other key members to build a stronger eurozone.

The first part of the plan has worked quite well. Macron has carried out a major reform of France’s labour markets, and also tackled training, unemployment insurance and some parts of the education system. He has cut taxes on companies, investment income, wealth and employment, in an effort to boost investment. He is currently busy with railway reform and has many other ideas in the pipeline.

The problem is with the second part of the plan. Macron wants to strengthen the banking union by beefing up the European Stability Mechanism (ESM), the EU’s under-powered bail-out fund, and making it a backstop for the Single Resolution Fund for banks. He supports the European Commission’s plans for a pan-European scheme for insuring bank deposits. He wants a eurozone budget – distinct from the EU budget – of “several percentage points” of GDP (his officials would be happy with 1 per cent). In the longer term he wants a European finance minister, with decision-making powers, responsible to a eurozone parliamentary body.

But reforms in France have not made the Germans willing to dance to Macron’s tune. Last year, the feeling among some top officials in Berlin was that they needed to give Macron something, to strengthen his position vis-à-vis France’s eurosceptics. This year the mood is different. As one Berlin official put it, “Why should we pay a price for reform in France? France is reforming because France needs to reform.” There are four reasons why Germany is resisting Macron’s plans for the euro.

First, Germany’s financial establishment continues to believe that the eurozone is doing fine. Germany and many other members have grown rapidly in recent years. German officials say that if other countries experience problems they should do their ‘homework’, comply with budgetary rules and implement structural reform – like Spain has done. They see no systemic weakness in eurozone governance.

Second, even if Angela Merkel wanted to cede to some of Macron’s requests, she is too weak to deliver much. Only 364 members of the Bundestag voted for her to be Chancellor, just nine more than the 355 required for a majority. A small rebellion in her own ranks would bring defeat. Both her allies in the Christian Social Union and the increasingly powerful right wing of her own Christian Democratic Union (led by health minister Jens Spahn) are virulently opposed to risk-sharing within the eurozone.

Third, a group of eight northern EU countries, led by the Netherlands, is working to strengthen Germany’s spine in its dealings with France. This ‘new Hanseatic league’ shares Berlin’s analysis of the eurozone and would block Macron’s more radical ideas if Germany went soft.

Fourth, Italy’s new government, dominated by the eurosceptic League and Five Star Movement, is hostile to Germany, eurozone budget rules and structural reform. This makes politicians in Germany and its allies extremely wary of any scheme that could entail transfers to the south.

Despite all this, officials in Paris and Berlin are concocting a modest agenda for reform that EU leaders can endorse at their summit on 28th and 29th June. France is confident that Germany will agree to the ESM becoming a backstop to the Single Resolution Fund. Could the ESM evolve into a European Monetary Fund (EMF), as some Germans – including Merkel in her recent interview with the Frankfurter Allgemeine Zeitung (FAZ) – have suggested? Though not opposed to an EMF per se, the French are wary of the German idea that it should be purely inter-governmental and take on some of the Commission’s tasks of supervising economies and bail-outs. France will not agree to the automatic restructuring of sovereign debt if the ESM/EMF lends, as some Germans desire, lest that spook the markets (Merkel has suggested giving the EMF the authority to impose restructuring).

France wants a bigger ESM/EMF, and one that can more easily grant ‘precautionary’ lines of credit – to a country that is not yet in dire straits – than can the ESM today. German officials could accept both ideas, but emphasise that the ESM treaty would need amending. They add that credit lines would come with conditions attached.

Germany shows no signs of agreeing to pan-European bank deposit insurance. Like its allies in the Dutch-led grouping, it sees this as a southern European scheme to grab northerners’ savings.

Macron is personally committed to a eurozone budget, in addition to a bigger ESM. The point of the ESM is to lend to a country when it loses access to bond markets. The budget, by contrast, would encourage eurozone convergence and investment, and help to stabilise member-states suffering asymmetric shocks (those affecting just one country). It would be spent on things like training and R&D. The French want all countries to pay into the budget in normal times; countries in recession, and therefore in need of help from the budget, would be excused contributions; and bond issues would make up the shortfalls. When problem countries returned to growth they would repay the budget. The ESM would raise the money and the Commission would decide on disbursement.

Germany can live with the idea of a budget to boost investment, but not the stabilisation function, and not bond issues that could resemble the dreaded ‘eurobonds’ (involving the mutualisation of sovereign debts) Even for the investment function, Germany doesn’t see why the eurozone rather than the whole EU should run the budget. It doesn’t like the idea of the eurozone becoming a political actor in its own right, to the exclusion of non-euro countries.

The Commission recently published plans for a €30 billion ‘European Investment Stabilisation Function’ within the broader EU budget, designed to help eurozone countries overcome asymmetric shocks. The Germans don’t like that purpose, while the French complain that the Commission proposal is too small (just 0.25 per cent of eurozone GDP). The Commission plan would make money conditional on compliance with the rules of the stability and growth pact, and the macro-economic imbalances procedure, to reassure Germany that the budget would not create moral hazard. French officials would attach a similar conditionality to their budget. But the Germans still oppose any kind of budget for tackling asymmetric shocks, even with conditionality attached.

The new Hanseatic league shares Germany’s hostility to Macron’s budget. But Italian officials have backed the French and one may guess that their new political masters would like loans from the budget, if not the conditionality attached. Spain has been more focused on the banking union but its new Socialist government will probably be sympathetic to Macron’s thinking.

A German official cautions that a eurozone budget would never get through the German parliament. “We’ll talk about improving the ESM at 19 and the EU budget at 27 – the latter could have a subdivision for the eurozone,” he said, adding that “if there is a case for a bigger EU budget [to help the eurozone] we will look at it.” Merkel told the FAZ that it remained unclear whether a eurozone investment budget should be managed inside or outside the EU budget, and that it could be “in the low tens of billions”. That is unlikely to satisfy Macron. One French official responded to her interview by saying “on EMU, it certainly goes in the right direction but it is insufficient – we do want to go beyond this.”

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