Thu, Oct 16, 2003 page9

• Is France the enemy of Europe?

  • By Melvyn Krauss
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  France under President Jacques Chirac is quickly becoming united Europe's biggest nightmare. It is bad enough Chirac is splitting Europe with the promotion of his so-called "multi-polar" foreign policy. Now France's blatant flaunting of the EU's Stability Pact, which caps deficit spending at 3 percent of GDP, is speeding Europe to an important crossroads that threatens to undermine both European monetary union and the euro itself.

  The EU's smaller countries, in particular, are furious with France over its stubborn refusal to play by the EU's deficit-spending rules. They see French defiance as more than just a narrow issue over fiscal numbers.

  "It concerns whether the big countries are willing to sacrifice any measure of national sovereignty for the European good," said one influential ECB official. "The Germans at least are trying to rein in their deficits," the official went on. "But the French simply do not care."

  The act precipitating the current crisis is France's decision to go ahead with the cut in the personal income tax Chirac promised during his election campaign of last year. The tax cut will put France's fiscal deficit over the 3 percent limit for three years in a row -- at an estimated 4.5 percent of GDP for next year -- because it will not be financed by offsetting cuts in public expenditure.

  Of course, some believe an income-tax cut is precisely what the French economy needs. Perhaps. But as attractive as an income-tax cut may look on narrow nationalistic grounds, there is more than just the French national interest to be considered. For if France can get away with its flagrant violation of the Stability Pact rules, others will follow the French lead.

  An orgy of deficit spending throughout the euro-zone economy is certain to result, as welfare state pressure groups in individual member states attempt to make up for prior restraint. This will cause many to have second thoughts about European monetary union. After all, who wants a monetary union that bloats the welfare state and is an engine for inflation?

  Moreover, once the constraints on deficit spending are off, a major incentive for badly needed structural reform in Europe will be removed. Europe's politicians will be tempted to simply jack up the fiscal deficit to boost domestic incomes rather than undergo politically painful but necessary rationalization. Structural stagflation -- high inflation and low economic growth -- will result.

  The EU Commission must act now or face a possible revolt from the smaller countries. Sweden's rejection of the euro already has sounded the alarm.

  Hitting the French with a hefty fine -- the penalty provided by the Stability Pact -- is not a good idea. Under its current rules, three big countries (France, Germany, and Italy) could -- and probably would -- block the sanction. Even if the penalty were imposed, the French would not pay.

  France's occupation of the Netherlands during the so-called French Period at the turn of the 19th century suggests a better alternative. France then imposed a penalty tax on the province of Zeeland for running a sizeable fiscal deficit. When the Zeelanders refused to pay, the French responded by centralizing what had been until that point a rather de-centralized Dutch fiscal system.

  What worked then may work now. Centralization of the public finances of member states, though a radical step, may be the only answer to the problem of recalcitrant countries like France that refuse to play by the budget rules.

  The issue of how much of a double standard the EU's smaller countries are willing to accept has been brought to a head by Chirac's blatant flaunting of the Stability Pact rules. By rejecting the euro, Sweden, itself a small country, made it clear that it didn't want to be part of a Europe that discriminated against small countries. What will it take, one wonders, before others among the smaller member countries follow suit?

  Melvyn Krauss is a senior fellow at the Hoover Institution, Stanford University. COPYRIGHT: PROJECT SYNDICATE
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