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Macron Impossible: French Labor Reform and the EU Budget

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Emmanuel Macron won an important election in May, when the young Frenchman defeated right wing populist Marine Le Pen to win the Presidency. In June, Macron’s new En Marche! party claimed another major victory, taking firm control of the French parliament.

In the ensuing months, Macron’s popularity has dipped a bit. This is a non-issue, the regular ebbs and flows of politics; coming in riding so high, he was bound to come back down to earth. To his credit, Macron has not tried to restore his popularity with cheap or symbolic victories. Instead, he is going right for big ticket reforms–the French Labor Code (Code Du Travail) and instituting an EU budget. Should he succeed in these herculean tasks we can forget about his approval ratings, as he would cement himself as one of the great French politicians in modern history.

The French Labor Code, the Code Du Travail, is a 3,324 page document whose origins are over one hundred years old. While I am certainly no expert on this subject specifically, it is essentially the same economic argument often heard in different contexts–worker protections vs. flexibility and growth. (Note: Just because I am advocating for looser worker protections in this case does NOT mean this is the answer in all cases. Economics is always context-sensitive.)

Ultimately this is about risk and faith–the risk of the unknown and faith that private sector growth can unlock more employment and offer a better standard of living than the current system. People are inherently risk averse, and France has a history–even a national identity–tied to championing the proletariat, which is why the Labor code currently looks the way it does:

“That hyper-regulation of much of French life, including labor, was formed in the early 19th century as part of the country’s escape from the chaos of the French Revolution.

“The emerging law,” a prominent Socialist wrote triumphantly in 1903, seven years before the birth of the labor code, “is a Socialist law.”

Indeed, at the heart of the code’s language is the notion that the worker is inevitably an exploitable object needing blanket protection from rapacious capitalist predators.”

Clearly, reform will be an uphill battle. But where there’s a will, and a need, there may be a way. The political will clearly exists, in the form of a President with a parliamentary majority who is willing to take on powerful unions and other dissenters. There is certainly a need to reform; French unemployment is too high at 9.6%, and youth unemployment is significantly higher at a whopping 23.4%. This is France we are talking about here, one of the world’s most developed countries and a pillar of the EU. Such high levels of youth unemployment risk both France and the EU’s future if left unaddressed.

The make reform more palatable, Macron will rely heavily on the idea that market forces can improve people’s lives. Greater demand for French exports would help bolster this argument, which is where his championing of an EU Budget comes into play (at least partially, it is a good idea on its own merits as well).

An EU budget would help the block’s economic performance. Look at the U.S.; in an economic downturn, the Federal government transfers tax revenue from better performing areas to struggling areas via stimulus spending, helping to speed up recovery. The EU needs something analogous if it wants to gain parity with the U.S. in terms of economic clout:

“Elected in May, the French leader is trying to reshape and strengthen the euro currency bloc by creating a euro zone finance minister and parliament, as well as a stand-alone budget to cushion against economic shocks and head off future crises.

But he is running into German resistance despite conciliatory public signals from Chancellor Angela Merkel. Her finance minister has proposed transforming the euro zone’s rescue fund, the European Stability Mechanism (ESM), into a fully fledged EMF with more powers to support weaker members.

“We should head towards a European Monetary Fund but this should in no way be mixed up with a (euro zone) budget,” Macron told Greek President Prokopis Pavlopoulos.”

Make no mistake, an EU Monetary Fund is certainly a good idea as well. But a budget and a Monetary Fund would be complementary institutions–there is no reason the Euro Zone could not implement both.

On the surface Germany remains opposed to fiscally supporting poorer European countries with direct transfers (this has been its position for some time). However, Germany does seem to be on board with an EU budget in the context of an expanded Euro Zone:

“[German Finance Minister] Schaeuble said that Juncker had discussed with Chancellor Angela Merkel his annual State of the EU speech in which he spoke of a vision of a post-2019 EU where some 30 countries would be using the euro.

The plan also includes appointing an EU finance minister running key budgets to help states in trouble.

“It is good that he is putting pressure (to expand the euro zone) but the preconditions (for joining the euro zone) must be fulfilled,” Schaeuble told the ARD broadcaster in an interview.

“It is in fact so that EU countries who fulfill the preconditions become members of the euro under the Lisbon Treaty”.

He added that EU countries wishing to adopt the single currency should not do so before their public finances and economies are sound enough as they could face the fate of Greece, which had to be bailed out by the EU and IMF in 2010.”

Rigorous “ex-ante” preconditions are absolutely warranted in this situation. Failure to have such conditions for joining a currency union, and relying too much on wishful thinking, can have disastrous results (just ask the Greeks…).

It seems, however, that in the wake of Brexit and seeing what failures of economic governance can mean, that at last the EU’s power players share the same long term vision–now comes the hard work of how to get there. To me, Macron’s plan seems more logical than Juckner and Schaeuble’s for both political and economic reasons.

Politically, by establish a Euro Zone budget and Monetary Fund for the current group, the Euro Zone will be stronger economically, making membership more appealing to outside countries. This would give ammo to political leaders who may have to sell certain unpopular reforms to their citizenries in order to qualify. Economically, a stronger Euro Zone would result in stronger trading partners for non-Euro Zone countries, helping them reach the aforementioned preconditions needed to join.    

Maybe I am being overly optimistic, but perhaps neither of these “impossible” but very important reforms Macron is pursuing–to France’s Labor code and the EU’s economic institutions–are as impossible as they once seemed.

Update: The results of the German election are in. With the far-right Alternative for Germany (AfD) and anti-EU leftist Free Democrats (FDP) performing better than expected, the prospects of closer EU economic integration certainly took a hit (although, in a bit of positive news, the FDP has seemingly softened its anti-EU stance since the election).

It will take true leadership from German Chancellor Angela Merkel to sell these necessary reforms to her coalition members. She will have to become an unabashed champion of these ideas, positioning them as the only means to promote long term economic growth for both Germany and the EU as a whole. It is unclear whether she is willing to take this position, but perhaps in her now fourth term, she is willing to sacrifice her political future to help move Germany and the EU towards the future they need.

Macron’s, for his part, is continuing to drive his vision. One avenue he will propose is greater democratization of EU institutions, as a means to popularize his vision among voters who believe the EU is unaccountable to it’s people.

This uphill battle just got a whole lot steeper…

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Economic Outlook: The United States of Europe?

https://i2.wp.com/upload.wikimedia.org/wikipedia/commons/thumb/8/84/Supranational_European_Bodies.png/400px-Supranational_European_Bodies.png

The title of this post is a bit of a joke, even in the unlikely scenario that such a federation is established, I’m sure they would make it a point to make a name less similar to that of the USA. What is not a joke is the state of the European economy, whose unemployment rate and output gap makes America seem like the a model of economic efficiency. (It is impossible to find a single EU or Euro Zone output gap figure, but one can safely assume based on unemployment levels that it is significantly large).

French President Francois Hollande made strong, if not novel, points.

“The French proposal, which Hollande said he would submit to his eurozone partners, also calls for much deeper fiscal integration between the eurozone nations, with a common budget and the authority to issue debt. The government would also debate the main political and economic decisions to be taken by member states and launch a battle against tax fraud.”

“He acknowledged he could face resistance from Germany, Europe’s dominant power, which opposes mutualising debt among member states. Berlin is also reluctant to give the euro zone its own secretariat for fear of deepening division in the EU, between the 17 members of the single currency and the 10 others.

Non-euro Britain’s government already faces growing domestic pressure to hold a referendum on leaving the bloc.

Hollande said he wanted Britain to stay in the EU but added: “I can understand that others don’t want to join (the single currency). But they cannot stop the euro zone from advancing.”

Hollande said a future euro zone economic government would debate the main political and economic decisions to be taken by member states, harmonize national fiscal and welfare policies, and launch a battle against tax fraud.

He proposed bringing forward planned EU spending to combat record youth unemployment, pushing for an EU-wide transition to renewable energy sources, and envisaged “a budget capacity that would be granted to the euro zone along with the gradual possibility of raising debt”.

He also called for a 10-year public investment plan in the digital sector, the promised energy transition, public health and in big transport infrastructure projects.”

Indeed, these concepts are not new. There has always been doubt as to whether the Europe had the necessary preconditions for a strong currency union (based on the theory of optimal currency area). There is considerable economic interdependence, but differences in language and culture make labor less mobile (which is why some countries in the EU have unemployment rates above 25%, while others are high but more manageable).

The head of the Economics department at Fordham, Dominick Salvatore, (a man whom I greatly admire) wrote about the issue of having a currency union without fiscal coordination in the early 1990s. He was probably not the only one to identify this obvious flaw. European leaders thought that by creating the EU and Euro zone, that greater coordination would naturally occur, however this has largely not taken place (at least with respect to fiscal coordination).

The E.U. is at a cross-roads (it has been at it for some time). Britain will eventually have a referendum on whether or not to stay in the EU (a few high level officials have recently signaled they would vote to leave). The economic recovery in Europe has been non-existent. If a stronger European economic government make the Euro zone project more sustainable, it would be in the best interest of both the 17 Euro Zone countries and the 10 countries in the E.U. but without the Euro.

I used to be worried about a E.U. breakup, but I do not think such an outcome would be as painful as a Euro zone breakup. The E.U. was recently given the Nobel Prize, a symbolic move emphasizing the importance of the block of countries in promoting democracy and human rights globally. But if the E.U. wished to merely become a FTA or  common market, I do not see any of the countries drastically changing their political ideology. All of these countries still have a shared history in which peace and trade led to mutually beneficial outcomes, while war and isolation led to pain and suffering; allowing countries to leave the E.U. to sustain the Euro Zone would not change this. Indeed, I do not believe there is any foreseeable outcome that could change decades of hard learned lessons .

Economic integration would continue to exist between non Euro Zone and Euro Zone countries. The Euro Zone, with a more unified political and economic voice, would undoubtedly be a more meaningful partner with the U.S. in terms of global governance. The Euro Zone would become more effective in global security measures, with a strong unified military–in this sense having the Euro Zone move forward without all of the E.U. would help achieve many of the original goals of the E.U.

There is no question that a monetary union cannot be sustained without fiscal coordination. President Hollande was dead on when he said “I can understand that others don’t want to join (the single currency). But they cannot stop the euro zone from advancing.” Sometimes you have to cut off the limb to save the patient, and it seems like this might be the case with the Euro Zone. E.U countries not in the Euro Zone could wake-up tomorrow, decide to leave, and as long as economic ties remained very little would change. If the Euro Zone fell apart, there would be unprecedented losses as countries scrambled to put the pieces of their monetary policies back together.

If allowing countries to leave the E.U. is what it takes to make the Euro Zone sustainable, then this option has to be explored. When has forcing someone to stay, when popular consensus is to go, ever led to a sustainable union? If countries want to go, they should be allowed to go, so that those who remain can move forward.

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Economic Outlook: The Ripeness of Cyprus


That ripeness refers to the need for Cyprus to diversify it’s economy. Ripeness may not be the right word, as Cyprus is not willingly taking these measures but rather having them imposed, but what else rhymes with Cyprus? (Lack of ripeness, like with this peach, is often a good indicator it is time to throw out said peach, no?)

“Cyprus has a huge banking system — assets around 8 times GDP — based on a business model of attracting offshore money with high rates and good opportunities for tax avoidance/evasion.”

The problem with such a large banking sector is that it creates asset bubbles and leads to  a loss of competitiveness in other sectors. As Cyprus now faces the inevitability of having to diversify its economy away from the banking sector, it faces the difficulty of having wages that are uncompetitive with the rest of its neighbors. It is difficult to be competitive in export industries with a high cost of labor and a high cost of living, as these costs ultimately fall on producers making their goods less competitive. A high cost of living also depresses tourism, as people will choose to go to cheaper destinations.

Transitioning to export based growth is tough in today’s economic conditions, even when labor costs constitute a comparative advantage. This is due to a slump in global aggregate demand, particularly with Cyprus’s current trading partners—EU countries. The EU remains mired with high unemployment and recessions (which are currently hitting Cyprus particularly hard as well), meaning that finding markets for diversified exports would be difficult. The high unemployment (14.7%) and recession conditions (-3.3% GDP growth Q4 2012) mean that Cyprus cannot rely on its domestic markets to buy its goods either.

For these reasons, Cyprus has been reluctant to admit that it must abandon its unsustainable reliance on the financial sector. Cyprus tried to secure an EU bailout by imposing a tax on banking deposits—a measure that Cypriots forcefully rejected. It seems that ultimately Cyprus will have to agree to spare small depositors (average citizens) and force large depositors (who are often foreigners who go to Cyprus as a tax haven) to take a large “haircut”. This would undermine confidence in Cyprus’s banking sector, leading to capital flight.

Cyprus could impose capital controls to prevent capital flight, as Iceland did in a similar situation. This, along with uncertainty of Cyprus’s future in the EU, could mean less FDI (uncertainty is a huge deterrent to investment, especially in the case of a potential EU-exit) which Cyprus will need to diversify its economy due to high levels of debt (84% GDP as of Q3 2012) and high borrowing costs (7% interest rates on long term bonds).

Cyprus is currently at a crossroads, a point summarized nicely by Paul Murphy at FT Alphaville:

“Big depositors in Cypriot banks stand to lose circa 40 per cent of their money here, which has drawn plenty of fury and veiled threats from Russia.”

“Cyprus now has a binary choice: become a gimp state for Russian gangsta finance, or turn fully towards Europe, close down much of its shady banking sector and rebuild its economy on something more sustainable.”

So how are Cyprus’s prospects for economic diversification? Actually, this is a potential bright spot in an otherwise dismal picture (for data, see end of the post):

Cyprus has increased its spending, per person, at all levels of schooling over recent years. There has also been a shift to more advanced technological manufacturing, which could be a growth industry (High-technology exports as % of manufactured exports have risen from around 4% in 1990 to close to 40% in 2010). Energy production, specifically a natural gas field adjoining the Cyprus-Israel border, has been discussed as a potential growth sector.

The problem is such exploration requires large upfront costs and profits will not be realized for at least a few years. Given Cyprus’s high borrowing costs, an immediate bailout is needed—Cyprus simply cannot afford to wait for its economy to diversify, even if it was able to secure the funding needed explore it’s gas fields and / or avoid a Euro Zone exit.

Luckily, Cyprus has been laying down the seeds of economic diversification, but those seeds are not ready to sprout. Economic diversification will be painful, based on the composition of Cyprus’s labor force (agriculture 8.5%, industry 20.5%, services 71% (2006 est.); presumably a large portion of people in the services sector work in financial services).

Compounding the problem; “There’s still a real estate bubble to implode, there’s still a huge problem of competitiveness (made worse because one major export industry, banking, has just gone to meet its maker), and the bailout will leave Cyprus with Greek-level sovereign debt.”

Cyprus needs the troika (IMF, ECB, and EC) to provide emergency liquidity to allow its economy time to diversify. There will inevitably be some growing pains—hopefully harsh austerity is not imposed as a condition for receiving these loans, although recent history suggests it will be. Some internal devaluation will be needed to make Cypriot wages competitive again—something that is politically and socially undesirable (as wages tend to be “sticky”) but an inevitable consequence of losing control of monetary autonomy (being in the EU, Cyprus cannot devalue it’s currency to increase export competitiveness)

Cyprus has been investing in human capital, and already has the infrastructure for export based growth through its advanced system of ports, what is needed is stimulus spending to help mobilize Cyprus’s factors of production away from the financial sector.

Just like a child who knows he must do something he doesn’t want to do, Cyprus initially faced it’s unfortunate reality by trying to return to its security blanket—the financial sector. Ultimately, Cyprus needs to be weaned off the teat of the financial sector—even Russia, the biggest loser if large depositors take a loss, has stated it will not extend financing to Cyprus until it secures troika financing (Cyprus pursued Russian financing as an alternative to a troika bailout, presumably to allow it continue with its unsustainable banking practices, in exchange for preferential exploration rights by Russian firms of Cyprus’s natural gas fields. These talks thankfully did not bear fruit, as they would’ve moved Cyprus in the wrong direction; doubling down on an unsustainable financial sector while compromising its most obvious means of economic diversification–it’s natural gas reserves).

It is important to avoid a Euro Zone exit, as this would undermine investor confidence which is needed alongside troika loans to allow Cyprus to diversify its economy. Ultimately, investors will react favorably if Cyprus admits its financial sector is unsustainable and commits to economic diversification. A sustainable economic outlook will attract investment, especially in an industry as profitable a natural gas exploration, but also in other sectors due to low taxes (10% corporate tax rate in Cyprus–lowest in the EU, can help offset the current high wages in Cyprus and temper the social costs of internal devaluation).

Uncertainty and trying to hold onto an exposed unsustainable financial sector will drive away investors. Everybody can now see that Cyprus will have to force a “haircut” on large depositors. The sooner Cyprus “takes its medicine”, the sooner it can get on the path to sustainable economic development.

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Economic Outlook: Economics in The State of The Union Address

Economics always plays a prominent role in the State of the Union Address, particularly during times of economic turmoil. Last night’s speech was no exception.

“President Obama, seeking to put the prosperity and promise of the middle class at the heart of his second-term agenda, called on Congress on Tuesday night to raise the federal minimum wage to $9 an hour, saying that would lift millions out of poverty and energize the economy.”

Raising the minimum wage would help put more money in the pockets of America’s poorest workers. As I have pointed out in previous posts, the lower your income, the greater your MPC (marginal propensity to consume). In other words, every dollar of income that goes to a minimum wage earner has a larger multiplier effect on the economy than that same dollar in the hands of a wealthier wage payer. In light of recent evidence of a corporate cash hoarding, this policy makes sense not only from an economic equality standpoint but also for economic growth.

“Our economy is adding jobs, but too many people still can’t find full-time employment,” he said. “Corporate profits have rocketed to all-time highs, but for more than a decade, wages and incomes have barely budged.”

In addition, by raising the wage floor, everyone else wages should rise as businesses have to adjust the wages they pay to attract more talented workers. This should lead to lower spending on entitlement programs as higher wages will cause less families to qualify for government programs. How far up the wage ladder these increases will trickle is open to debate, but as this is a secondary benefit of raising the minimum wage it should be considered “icing on the cake”.

“On trade policy, the president said that the United States and the European Union were ready to begin negotiations on a comprehensive trade treaty. That came after a report submitted earlier in the day concluded that the gaps between the two sides were narrow enough to put a deal within reach.”

Greater trade openness with Europe will stimulate the economy by provide consumers with lower prices for goods (and therefore more disposable income). A Closer relationship with the E.U. will also allow for greater monetary policy and currency coordination, which is important given the similarities between the American and E.U. economies.

“Mr. Obama pledged to work with states to provide high-quality preschool to every child in America. And he recycled a proposal to help homeowners refinance their mortgages.”

Evidence suggest that early childhood is the most important time period for cognitive, emotional, and social development; investing in high quality public pre-schools ensures that all children, not just those of well off parents, have the ability to reach their full potential. Homeowners deserve more help in coping with the housing crisis; Main St. did not get anywhere near the same bailout as Wall St. did, and many families are still struggling with “underwater” mortgages. Helping families restructure their mortgages would help stimulate the economy for similar reasons as raising the minimum wage (by putting more money in the pockets of those who will spend it).

“On climate change, Mr. Obama endorsed the cap-and-trade legislation once championed by Senator John McCain, Republican of Arizona, and former Senator Joseph I. Lieberman of Connecticut, but long stalled in Congress. Though the president said he would not hesitate to use executive orders to push his own measures to reduce carbon emissions, he did not give any details.”

Cap and Trade should already be U.S. legislation. It has strong bipartisan support and makes sense from an environmental and economic point of view. It is because of special interests (lobbyists) that we do not currently have such legislation. Hopefully congress can come together and pass a bill, although recent history suggest they will not be able to. It will be interesting to see what sort of executive orders Obama has in mind to reduce carbon emissions.

In the G.O.P. rebuttal, Sen. Marco Rubio had (unsurprisingly) some choice words for President Obama:

“’I hope the president will abandon his obsession with raising taxes and instead work with us to achieve real growth in our economy,’ Rubio said in the formal Republican response to Obama’s speech.”

Isn’t it interesting that to the G.O.P., “real economic growth” cannot come from government spending? Ask the families of school teachers and police officers how “real” their wages are, ask anyone how “real” their contribution to society is. Ask local businesses (or miltinational corporations too for that matter) if they care whether a public or private sector employee buys their good or service, I guarantee you they do not. Of course the private sector has the play the dominant role in our economy, that doesn’t mean that government spending shouldn’t play any role. It is especially important to have stimulus spending when private demand is low in order to keep the economy growing (weak public sector spending is a major reason for the slow economic recovery both in the U.S. and around the world).

For his part, the President does not seem to be backing off his call for higher taxation and greater government spending:

“ Mr. Obama also signaled, however, that the era of single-minded deficit-cutting should end. He noted that the recent agreements on taxes and spending reduced the deficit by $2.5 trillion, more than halfway toward the $4 trillion in reductions that economists say would put the nation’s finances on a sustainable course.

Mr. Obama spoke darkly of the consequences of a failure to reach a budget deal, which would set off automatic spending cuts on the military and other programs. “These sudden, harsh, arbitrary cuts would jeopardize our military readiness,” he said.”

The government does have a role to play in ensuring markets function properly; government intervention is an essential component of capitalism. Obama has apparently shifted the middle of the political spectrum to the left. The G.O.P., after losing the presidential election, has taken on a “re-branding” of sorts, while the Democratic Party has doubled-down on its ideological stance (and increased the divide between the legitimacy of the two parties; one is sticking to it’s guns and has popular / scientific support, the other is re-branding itself in an attempt to maintain political relevancy).

Will the G.O.P. get on board with Obama or continue to drag its collective feet? How the G.O.P responds to democratic proposals over the next few months will go a long way in determining how many seats it will win in the 2014 congressional elections.

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