June 14, 2002

David Hale Sees Continental Europe Swinging Right--and to a Reformist, Not a Static Right

David Hale, Chief Economist at Zurich Financial Services, believes that right-of-center governments are likely to dominate continental Europe for the next five or ten years or so, and that these governments will be "reforming" governments rather than static governments. But I'm not sure why he believes this. Europe's governments have always seemed to me to have overwhelming continuity-of-personnel with the past (as opposed to the circulation-of-elites pattern of American governments), and this seems to me to make major reforms of any kind relatively unlikely.

FT.com | ANALYSIS: Europe revisited, by David Hale

Financial Times; Jun 14, 2002

The odds are very high that a majority of European Union countries will have centre-right governments this autumn. During the past two years, parties of the right have won victories in Austria, Italy, Spain, Portugal, Denmark and the Netherlands. France is poised to join them. And on the basis of current opinion polls, the right appears to be heading for victory in Germany during September and Greece next year.

The victories for conservative parties in France and Germany are of potentially great significance because they could set the stage for the most aggressive programmes of microeconomic reform and tax reduction that the European Union has ever known.

Germany had a conservative government from 1983 to 1998 under Helmut Kohl but it was too absorbed in unification and European monetary union to focus on issues such as labour market deregulation and tax reduction.

The French conservative government of the mid-1990s introduced some significant tax reductions for employers of low-income workers, which helped to promote employment growth during the late 1990s. But the government lost power before it was able to tackle other critical issues such as pension reform and broad-based tax reductions.

There is still great uncertainty in the financial markets about exactly what new conservative governments might do in France and Germany. Before the election, Jacques Chirac, the French president, campaigned for tax reduction and greater microeconomic flexibility in the application of the 35-hour working week. The German conservative coalition under the leadership of Edmund Stoiber has promised numerous reforms in taxation and employment policy but it has been deliberately ambiguous about laws affecting job security.

Mr Stoiber's conservatives have outlined an agenda with three principal themes. First, they want to reduce the government share of gross domestic product from 48 per cent to 40 per cent. Second, they want to reduce the level of social overhead taxes to less than 40 per cent. Last, they want to reduce the top marginal income tax rate to 40 per cent from 48 per cent.

Germany's conservatives also plan to introduce tax allowances for children. The idea is to reverse Germany's declining birth rate and to restore a tax incentive programme created by the Kohl government to encourage job creation among low-income workers but repealed by Gerhard Schry´der, the chancellor. This programme would exempt employers from paying social overhead taxes on workers earning up to €400 ($378) a month or possibly even up to €600 a month. The Schry´der government's decision to eliminate this tax incentive probably cost the German economy 300,000 jobs and explains in part why unemployment is so high today.

The CDU/CSU coalition has been reluctant to make any commitments about laws that curtail the freedom of employers to fire people. However, the Free Democratic party, its probable coalition partner, is committed to far-reaching labour market liberalisation. On the basis of current opinion polls, the FDP could enjoy an unprecedented 14 per cent of the vote this autumn and thus be a far more influential coalition partner than ever before.

A CDU/CSU victory in the autumn would shatter all political precedents in Germany. Mr Schry´der would be the first chancellor to lose office after only one term. Such a defeat would signify that his attempt to duplicate the so-called Third Way politics of Tony Blair and Bill Clinton was inappropriate for a country that did not experience any preceding period of significant microeconomic reform under a leader comparable with Margaret Thatcher or Ronald Reagan. The Third Way is viable only after a protracted period of market-oriented reform to set the stage for good economic performance. In the case of Germany, the Third Way diverted the government from reforms desperately needed to reduce unemployment.

Markets are always slow to discount political change because of investor scepticism about the quality of political leadership everywhere. But if the German and French governments do pursue significant tax reduction and microeconomic reform, they may set the stage for a fundamental change in the direction of global capital flows. If the new rightwing governments revive investor confidence in the prospects for European structural reform and growth, European stock markets will rally and create serious competition for capital with the New York markets after a long period of American ascendancy.

The Bush administration has not yet had time to contemplate the consequences of a sustained dollar decline resulting from a new, pro- growth political environment in Europe. But it could at last permit the US to reduce its burgeoning current account deficit without resorting to new forms of protectionism. Such a development would be a positive force for economic growth everywhere.

Posted by DeLong at June 14, 2002 02:48 PM


"Europe's governments have always seemed to me to have overwhelming continuity-of-personnel with the past"? Thatcher, Aznar, Berlusconi - leaders of 3 of Europe's big five countries - I think you're a touch demanding here Brad if you don't see any structural political breaks.

And as for "this seems to me to make major reforms of any kind relatively unlikely", everywhere, even in countries where politics may be more glacial, Europe is reforming and pretty radically. Think about telecoms, energy, or airlines. State aid is vanishing and competition is getting tougher for car companies. Have a look at http://europa.eu.int/comm/internal_market/en/update/economicreform/index.htm for some data and text to provide a rosier view of Europe.

Posted by: on July 9, 2002 05:33 AM

sorry, accidentally left my name off my comment above

Posted by: John Sheehy on July 9, 2002 05:34 AM
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