In memory of Dr. Andreas Höfert

France and the euro – 30 years of zigzag

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Within the euro, France is the weakest of the strong countries and the strongest of the weak ones. All attempts to split the euro into a North and a South fail to position France. A northern euro without France is a return to the Deutschmark, while a southern euro without France cannot be justified by the trade flows between the Southern European countries.

Despite its position, France’s relationship towards the common currency is all but fuzzy. Former President Nicolas Sarkozy closely shadowed German Chancellor Angela Merkel. The new President François Hollande in contrast now spearheads an alliance with the Italian and Spanish prime ministers, Mario Monti and Mariano Rajoy, trying to isolate Germany. One might call this about-face in policy normal, given the change in government last May.

In my view though, the causes of such disorientation go back at least 30 years, prior to the euro. France, then searching to reinvent its economic model, did not quite succeed. The existential quest thus continues.

Capitalism against capitalism

In 1991 economist Michel Albert, back then CEO of Assurances Générales de France (AGF), wrote a French economic bestseller Capitalisme contre capitalisme. His main thesis was that there were not one but two types of capitalism: Anglo-Saxon capitalism and Rhine capitalism.

In 1991, the US and the UK, both of the Anglo-Saxon variety, were facing recessions, while Germany and Japan, both Rhine types of capitalism, were in the middle of the former’s reunification boom and at the peak of the latter’s housing and stock market bubbles. Michel Albert concluded that Rhine capitalism was more successful and hence would be the model best fitting France. Ironically, 1991 became the starting year of the Anglo-Saxon decade; Germany and Japan became the lame ducks in the 1990s and even in the first years of the 2000s.

This aside, why would a French economist even be interested in looking into different capitalism models and trying to find a new one for France in the early 1990s? Understanding this requires going back yet another 10 years to the early 1980s.

From Keynesianism with a Marxist touch to competitive disinflation

May 1981 saw the election of François Mitterrand as French president. For the first time in over two decades, France had a leftist government including some communist ministers. Mitterrand’s victory was a result of the rather grim economic environment of the 1970s.

Post-World War II France, like other Western European countries, experienced almost 30 years of strong growth and low unemployment. The so-called “trente glorieuses” (glorious thirty) ended with the oil shocks of the mid-1970s.

Until then France, similar to Italy, had a mix of strong growth, low unemployment, rather high inflation and recurring periods of currency devaluation. While inflation remained high in the late 1970s, suddenly growth stalled and unemployment increased.

Between 1981 and 1983, François Mitterrand tried an extreme leftist version of what had worked so well during the trente glorieuses: to boost growth through expansive fiscal and monetary as well as through structural measures. He nationalized 38 banks and 11 major industrial firms; this was the Marxist part of the program.

This policy failed dramatically. Unemployment continued rising, inflation spiraled out of control and the French franc devaluated over 20% against the Deutschmark between 1981 and 1984.

Despite this devaluation, the French trade balance deteriorated strongly. Old-style Keynesian economics didn’t work anymore. In 1984, the French socialists did a U-turn by implementing austerity and adopting a policy labeled “disinflation competitive,” or the strong-franc policy. Acknowledging the German paradox that a strong-currency country can have a structural trade surplus, France tried to mimic its northern neighbor and to peg its currency to the German mark, laying the foundation of what became the euro 15 years later.

Where France stands now and why it is important

The competitive disinflation policy successfully curbed French inflation, but its success is dubious when it comes to unemployment – still high – or trade – still structurally in deficit. Hence, having been a consensual policy through several changes in government over the last 25 years, competitive disinflation has been challenged quite often by French politicians from both political camps. The euro skeptics and those who want to return to the French franc especially at the far right and the far left are contesting this policy.

It is paramount for the future of the euro to know where France wants ultimately to go. Germany will never question its Rhine model: a currency, which rises in the long run based upon low inflation and moderate progression of unit labor costs.

Pushed to its limits by too much austerity, Italy might eventually revert to its pre-euro model: devaluation of its own currency and acceptance of higher inflation reflecting a stronger progression of unit labor costs.

Both export-led models have their advantages and disadvantages. At present the German model prevails. France has tried hard to follow it for over a quarter of a century. The new alliance François Hollande has forged could ultimately undo what his spiritual father François Mitterrand built in the mid-1980s. This would be another existential threat to the common currency.