As the smoke clears from recent elections in Europe, and as important as the election of Francois Hollande may turn out to be, in the immediate future one thing seems clear: Greece’s Alexis Tsipras, head of the far-left Syriza coalition, may be holding the strongest hand, both in Greece and in the eurozone more generally. Wharton Finance professor Franklin Allen offers his views on the immediate situation in this conversation with Knowledge at Wharton.
Knowledge at Wharton: Professor Allen, how would you characterize the significance of Socialist Francois Hollande’s recent victory in the French presidential election?
Franklin Allen: I think there are a number of reasons for his victory. In the end, the result was quite close. If [outgoing French President Nicolas Sarkozy] had not been so personally unpopular, he probably would have won. So it is not clear the election result is a rounding endorsement of Hollande’s policies. Nevertheless, clearly these did play a part and they are a move away from stark austerity. The lowering of the retirement age back to age 60, the increase in the minimum wage and other measures will cost money. The 75% tax on incomes over a million euros won’t be enough to pay for this. So, the question is where will the revenue come from, and are the deficit targets required by the European Commission (EC) realistic anymore? I don’t think we have enough information to judge at the moment.
Knowledge at Wharton: Support for austerity is fading fast across Europe. Even Olli Rehn, the European Union’s top economic figure, now says euro countries may need to loosen some of the strict budget limits already agreed to. But what other specific policy changes might actually make a difference — what tools does Hollande have to wield in France realistically, for example?
Allen: Yes, this is the problem. If you don’t spend money, then the kind of restructuring of the various markets that [pro-austerity officials] talk about take a long time to have an effect. This is why Hollande wants to change the ECB [European Central Bank] mandate and allow them to do quantitative easing directly. But I doubt the Germans will yield on that.
He says that the ECB should introduce pro-growth measures in addition to making cuts in government spending, and that the ECB should lend directly to governments, rather than through the banks. One of his aides also mentions eurobonds as a help.
How much would these measures help? In the short term they may help. But I do not think they will help in the long term. The problem is that the way they achieve their effect is to distort prices. The housing bubble is an extreme example. They create problems for the future in my view.
Knowledge at Wharton: What other measures could Hollande realistically take – at either the euro-wide level or the individual country level?
Allen: He can go after the rich in a much more emphatic way. One policy that has not been raised, because the governments have been center right, is a one-off wealth tax to get the debt down. I think this may be something the French Socialists move towards. Greece is the more interesting election result at the moment. The troika has basically hurt the center there. [The troika includes the EC, the ECB and the International Monetary Fund (IMF).]
We will see what happens in the next election in a few weeks. But if [Alexis Tsipras, head of the far-left Syriza coalition in Greece that came second in the election] wins, they will default and leave the eurozone. This will be a major problem for [Angela Merkel, the German chancellor] and for the IMF because this time the default will be against the official sector. Merkel will have to explain to German voters why tens of billions of euros have been lost. The IMF will have to explain why they are in the business of transferring money from poor countries around the world to rich European ones. Neither will want to do this, and Tsipras knows this. He will be in a much stronger negotiating position.