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Now Britain, Not France, Risks Being ‘Sick Man’ of Europe

Posted by hkarner - 16. Juni 2017

Date: 15-06-2017
Source: The Wall Street Journal By Simon Nixon

Despite the triumphalism of Brexit advocates, the U.K.’s cross-Channel rival is better placed for growth

It is often underappreciated just how quickly a country’s fortunes can change. In 2004, Germany was considered the sick man of Europe. Five years later, after some judicious reforms to its labor market, it was Europe’s economic powerhouse. Four years ago, Spain was widely dismissed as an economic basket case, one step away from national bankruptcy and euro exit. Yet since mid-2013, it has been growing at around 3% a year and created two million jobs.

That points to a second aspect to economic turnarounds: They are rarely obvious at the time, even to the economists, policy makers and pundits paid to spot these things. Famously, 364 distinguished economists—among them Mervyn King, who later became governor of the Bank of England—wrote to the Times in 1981 to warn that Prime Minister Margaret Thatcher’s policies were doomed to fail. Yet history shows that Britain’s recovery began at almost exactly that moment, and five years later its economy was booming.This unpredictability is worth bearing in mind as one surveys the current European economic landscape. At the time of last year’s Brexit referendum, it was taken as axiomatic by many in the U.K. that France was one of the leading contenders for the unwanted title of “sick man” of what was widely assumed to be a doomed eurozone; Britain, in contrast, was Europe’s most dynamic economy, one that needed only to unshackle itself from the continental corpse to seize opportunities in a globalized world and reach even greater heights of prosperity.

Yet following the very different outcomes of this month’s elections in France and the U.K., the tables have been well and truly turned.

The gloom about France was always overdone. The French economy has some significant strengths that the U.K. can only envy, not least a growing native working-age population and high productivity: The average French worker produces in four days what a British worker produces in five, according to figures from the U.K.’s Office for National Statistics.

France’s problem centers on rigid labor laws and high taxes, particularly on companies, that have held back investment and hiring, leading to unacceptably high levels of unemployment. The previous government of President François Hollande made some modest steps to tackle these problems. Now President Emmanuel Macron is proposing to go much further, with plans to cut corporate taxes, cap the costs of firing employees and make it easier for wages to be set at firm level rather than nationally.

Mr. Macron has been consistently underestimated. First, the doubters said he couldn’t win the presidency; then they said he couldn’t get a parliamentary majority. Now that he appears on the cusp of winning a landslide in Sunday’s second round of parliamentary elections, they say he his reforms will be defeated by the unions on the streets.

That is of course a risk, but Mr. Macron has a powerful mandate and a record of delivering reforms. If he succeeds, an analysis of similar reforms in other countries suggests his plans could boost France’s potential annual growth rate from its current 1% to 1.5% over the next five years, reckons Gilles Moec, chief European economist at Bank of America Merrill Lynch. Factor in a strong cyclical recovery and plenty of spare capacity and France could easily grow well above potential without overheating over the coming years.

In contrast, the case for the U.K. was never as rosy as claimed. The economy’s recent strong growth performance was largely driven by immigration and foreign direct investment, both of which have been thrown into doubt by the Brexit vote: The Conservative government wants to reduce immigration to below 100,000 a year in five years, while its Brexit plans require the U.K. to quit the European Union’s single market and customs union, which will inevitably result in new barriers to EU trade and disruption to supply chains.

Indeed, the economic fallout from Brexit is already emerging. Consumer spending, which buoyed the economy after the referendum, is stalling as higher inflation caused by the pound’s slump eats into living standards. Average earnings fell by 0.6% in real terms in the three months to April compared with the previous year; growth slowed to just 0.2% in the first quarter, with surveys pointing to a similar outcome in the second. That compares to eurozone first-quarter growth of 0.4% in France and 0.6% in the wider eurozone.

Now the U.K. election has created fresh political risks. The chances have risen sharply of a chaotic Brexit, whether because Britain fails to reach a deal with Brussels or is unable to put the necessary arrangements in place to ensure businesses can keep trading. Britain also now has a weak and wobbly government that is one political crisis away from yielding power to a Jeremy Corbyn -led left-wing Labour Party whose re-nationalization and taxation plans are likely to have a chilling effect on investment.

Meanwhile, the U.K.’s greatest strength—its currency flexibility—risks becoming a weakness as tough decisions are ducked in favor of periodic devaluations in the manner of pre-euro Italy, notes Ian Harnett, chief economist of Absolute Strategy Research. That could lead international investors to demand higher risk premiums to hold British assets.

Last year’s triumphalism over Brexit referendum now looks like hubris. On a five-year view, France is a good bet to become Europe’s new powerhouse. The U.K.’s challenge is to avoid becoming its new sick man.

 

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