Euro area reform hanging in balance

The comments French President Emmanuel Macron made with regard to Greece being on the road to recovery and the need for its eurozone partners to help it make progress by providing it with debt relief will, naturally, be the subject of immediate focus in Athens.

The same goes for the warm words regarding closer cooperation between French and Greek businesses, and potential investment from France in the future. However, it is Macron’s ideas about reshaping the eurozone that will have lasting impact and which should ultimately be the issue that Greece and its eurozone partners pay most attention to.

During his two-day visit to Athens, the French leader set out many of the ideas he had already shared with voters and fellow European leaders in previous months. Delivering these same lines in the Greek capital perhaps carried a greater resonance given that Greece has suffered like no other eurozone country over the last decade and been a source of such friction on matters of political ideology and economic theory within the European Union.

Macron called for the euro area to “get out of this sort of internal civil war whereby everyone looks at their little differences.” Greece is acutely aware of the damage this internecine strife can do.

Some of the proposals Macron sketched out in Athens included the International Monetary Fund being excluded from future bailout programs for eurozone countries and for its place to be taken by a revamped European Stability Mechanism. “As far as I am concerned, the IMF had no place in EU affairs,” he said. “Let’s work within Europe and not turn to outside agencies.”

The French liberal also proposed the appointment of a eurozone finance minister and the creation of a budget for the single currency block.

The current Greek government would like very much to see the back of the IMF (although in the short-term, this does raise questions about whether it might also lose its strongest advocate for debt relief, unless France is willing to play the role), while all the mainstream parties in Greece seem enthused by the idea of creating a budget that will be large enough to correct some imbalances in the euro area.

The creation of a European Monetary Fund has Germany’s backing and has been publicly promoted by Finance Minister Wolfgang Schaeuble. However, it imagines the common budget very differently to how Macron sees it in his effort to “rebuild Europe.” Berlin does not want a policy tool to be created that would allow the fiscal transfers that so many in Germany dread to be implemented through the back door.

While Macron believes that this budget could be used to achieve greater convergence between the countries using the euro, German Chancellor Angela Merkel envisions something on a much smaller scale – a fund for rewarding member states that carry out reforms. In a news conference at the end of August, the German leader explained that she imagines a budget made up of “small contributions” rather than “hundreds of billions of euros.” It would be unlikely that a common budget of this size could fulfill the tasks of boosting investment and cushioning shocks during crises.

Merkel faces a tough balancing act because she is fully aware (especially ahead of September’s national elections) of the lack of appetite within her country for anything that looks like fiscal transfers or a mutualization of debt. However, she would also like to see Macron succeed in his own country because his failure could boost nationalism and euroskepticism, possibly bringing Marine Le Pen to power in the future and putting the future of the euro in doubt.

The result of the upcoming elections in Germany could prove decisive in how much ground Merkel is likely to concede to Macron over the idea of eurozone reform. The possibility of Merkel’s Christian Democrats (CDU) going into power with the liberals, or Free Democrats (FDP), rather than the Social Democrats (SPD) is causing some concern among those who would like to see the eurozone act on some of the lessons it has learned during the crises it weathered over the past few years.

The FDP has much more conservative positions on economic policy and Europe than the SPD, while its lead, Christian Lindner, has ruled out further bailouts for Greece and even advocated the idea of the country leaving the euro.

“He is therefore likely to curb Merkel’s ability to strike a big bargain on structural reforms and looser fiscal policy with French President Emmanuel Macron,” wrote Olaf Storbeck for Reuters Breaking Views last month. “Political pressure to take a tough stance on Europe will be all the greater if the far-right Alternative for Germany wins seats in the Bundestag, as looks likely.”

For the time being, Merkel has been careful not to appear opposed to change in the euro area but, pending the formation of Germany’s next government, has advised Macron to focus on the reforms that he has proposed to improve his own country’s economic performance.

The danger, though, is that Macron could very easily become absorbed in the attempt to improve France’s competitiveness and growth figures, which would drain his energy and political capital, and kill any momentum for eurozone reform. The French president has launched his domestic efforts with proposals for reforming the labor market. While he has managed to gather some political backing for these changes, their potential economic impact is a matter of some debate.

Writing on this subject last week, economist Dani Rodrik underlined that “it has proved difficult to establish a clear empirical relationship between employment protection and labor-market performance” and warned that we should have “little confidence” that Macron’s labor reforms will boost employment in France.

If the liberalization of the labor market does not have the desired effect, Macron could find himself boxed in. “The trouble is that Macron has too few arrows in his quiver when it comes to lifting French economic growth,” writes Rodrik. “In terms of macroeconomic policy, his hands are tied in the eurozone, and there is little prospect that Germany will help by boosting its investment and spending.”

Apart from Macron, there will be many in the eurozone hoping his drive to make necessary changes to the single currency does not become mired in France. Otherwise, the eloquent words about European ideals and the speeches with the Parthenon as a backdrop will end up seeming like cheap souvenirs of a brief break from a rather dour routine.