Hollande's Nixon in China moment?

The Germans have blinked. In the last few weeks, Angela Merkel's acquiscence to more aid and more flexible aid terms for troubled eurozone countries have become clear. The Washington Post reports:

In both words and deeds, Merkel has in recent weeks signaled a willingness to embrace more-radical steps in the race to save the euro while sounding a more conciliatory note on the plight of Germany’s troubled neighbors. Her newfound pragmatism, observers say, could prove decisive in resolving a debt crisis that will mark its third anniversary next month.

She justified her volte-face to the German people by embracing Europe:

“European integration has allowed a dream of earlier generations to become a reality,” Merkel says in a video spot that is part of an “I Want Europe” campaign launched last month by corporate and cultural foundations here and aimed at frugal German taxpayers who are increasingly skeptical about the price they are paying to save the euro. Her words also seemed to harbor a message for other Europeans worried about growing German authority. “We have it to thank for our peace, our prosperity and our good understanding with our neighbors.”

As I wrote before (see An inflection point for Europe?), Merkel has managed to isolate the hardliners at the Bundesbank with the likes of ECB board member Joerg Asmussen. Another reason for optimism is the convergence in labor costs between the north and south.


Now it's France's turn
Perhaps this is all orchestrated, but the French seem to be bending too. French president Hollande addressed his nation on TV last Sunday to outline his economic plan for France. Much of the measures were to be expected from a left-of-center president, namely the refusal to shrink government staffing and tax increases:

Hollande said last week that by holding state spending steady next year in nominal terms, excluding debt servicing and pension payments, his government would save 10 billion euros in inflation-adjusted terms.

However, that would amount to just one third of the more than 30 billion euros in savings which Hollande says are needed to hit next year’s deficit target and stay on course to balance the budget by the end of his five-year mandate.

With his government refusing to cut staffing levels, the bulk of the adjustment will have to come from tax rises.

He said the remaining 20 billion euros would come from tax hikes on companies and wealthier households.

What was a surprise was his promise to take on the unions [emphasis added]:

Hollande said he expected unemployment, which is at 13 year highs, to begin to fall within a year as his proposals to create 80,000 subsidized jobs and to hire 60,000 people in the education sector as well as a so-called "generation contract" to encourage companies to hire young workers kicks in.

The new Socialist head of state has tried to break from his predecessor Nicholas Sarkozy’s pushy manner, promising to consult with social partners but gave unions until the end of the year to reach a "historic compromise" on labor reform or said the government would act unilaterally.

Hollande, being a socialist, is in a much better position to take on the unions than the right-wing Sarkozy and this may be Hollande's Nixon goes to China moment. Another signal of this shift was the release of a government study on PSA Peugeot:

French auto giant PSA Peugeot Citroen was Tuesday warned it must restructure urgently and tie up with a global group after posting sweeping losses due to strategic errors over two decades.

A damning government-sponsored report said Europe's second-biggest automaker after the VW group and which recently entered a limited alliance with General Motors of the United States, had missed the bus on globalisation.

Like Merkel, the French government has done an about face on its "core values" [emphasis added]:

The report was commissioned by the new Socialist administration of President Francois Hollande against the background of a plan by the group to close a landmark plant north of Paris and shed 8,000 jobs across France.

French Minister for Industrial Renewal Arnaud Montebourg, who had attacked the job cuts and PSA's corporate strategy, had conceded that it was "really in trouble" and needed "restructuring," a union official told AFP.

Franck Don from CFTC union said Montebourg would propose tripartite meetings between the state, union officials and the management to "review" the mass lay-offs and other plans.

"Therefore his position in July has been totally forgotten," he said.

All of these political shifts appear to be part of the Grand Plan outlined by ECB president Mario Draghi in a WSJ interview in February 2012. Certainly, Hollande's "generation contract" to lower youth unemployment sounds like a version of the Grand Plan, albeit with a French flavor. Back in February, Draghi sounded off on the structural rigidities of the European labor market that was creating a lost generation of young people [emphasis added]:

WSJ: Which do you think are the most important structural reforms?


Draghi: In Europe first is the product and services markets reform. And the second is the labour market reform which takes different shapes in different countries. In some of them one has to make labour markets more flexible and also fairer than they are today. In these countries there is a dual labour market: highly flexible for the young part of the population where labour contracts are three-month, six-month contracts that may be renewed for years. The same labour market is highly inflexible for the protected part of the population where salaries follow seniority rather than productivity. In a sense labour markets at the present time are unfair in such a setting because they put all the weight of flexibility on the young part of the population.

He went on to say that the European social model was dead:

WSJ: Do you think Europe will become less of the social model that has defined it?

Draghi: The European social model has already gone when we see the youth unemployment rates prevailing in some countries. These reforms are necessary to increase employment, especially youth employment, and therefore expenditure and consumption.

WSJ: Job for life…

Draghi: You know there was a time when (economist) Rudi Dornbusch used to say that the Europeans are so rich they can afford to pay everybody for not working. That’s gone.

One of the key steps to the death of the social model is to take on the unions. If French president Hollande is indeed taking steps to tackle that task, then it does represent progress in fixing the structual problems of the eurozone.


Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

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