ifo Viewpoint 260: New Euro Crisis Ahead Due to Power Shift in France?
In the first round of the French parliamentary elections, the right-wing populists of Rassemblement National (RN) and the left-wing populist coalition known as the “New Popular Front” together secured nearly 60% of the votes. The decisive runoff is scheduled for July 7. It is becoming increasingly clear that the balance of power in France is shifting. The emerging parliamentary majority could fundamentally alter the country’s economic and financial policies, potentially exacerbating France’s already significant national debt. This shift might compel the Eurozone community, including Germany, to assist in financing French deficits.
Ambitious Plans of the Winning Parties
The New Popular Front aims to increase government spending by around 150 billion euros. Their agenda includes reversing Macron’s recent increase in the retirement age from 62 to 64 and raising public sector wages by 10%. Additionally, they propose expanding the number of government employees and making school meals, public transportation, and other fee-based services free of charge.
Currently, government spending in France already amounts to over 57% of the country’s economic output. Under the new proposals, this figure would rise to approximately 63% of GDP. The increase in spending would be partially financed by higher corporate and wealth taxes, with the remainder likely covered through additional borrowing. Implementing these plans could potentially plunge France into a severe economic crisis.
On the other hand, the right-wing populist RN aims to secure its own majority but might also gain support from the moderately conservative Republicans. While the RN lacks a detailed fiscal policy program, its candidate for Prime Minister, Jordan Bardella, has made several promises to voters. Bardella intends to reverse Macron’s retirement age increase for those who started working before age 20, allowing them to retire at 60. Additionally, he proposes reducing the VAT on electricity, gas, petrol, and heating oil from 20% to 5.5% – a belated concession to address the concerns of the Yellow Vests movement.
However, Bardella has not specified how these measures would be funded, suggesting they may require additional borrowing. As of 2024, France’s budget deficit already stands at 5.3% of GDP, with the national debt ratio at 112% of economic output and showing an upward trend.
Implications for French Economic Policy
If Macron’s party decides to collaborate with the New Popular Front to prevent an RN majority and succeeds, it would likely lead to an increase rather than a reduction in France’s budget deficit. The New Popular Front would likely demand the implementation of at least part of its program as a condition for cooperation.
Should this scenario unfold, what would be the impact of increased borrowing on France, and what would be the repercussions for Germany and the rest of Europe? The mere announcement of excessive deficit financing can severely undermine confidence in the fiscal stability of even major industrial nations, as demonstrated by the experience of British Prime Minister Liz Truss in September 2022. Her plan to combine higher public spending with tax cuts, despite already high deficits, caused a sharp drop in the value of British government bonds. The Bank of England had to intervene significantly, and stability was only restored after the plans were withdrawn and Truss resigned.
Could a similar situation threaten France? While financial market pressure could potentially prevent destabilizing fiscal policies, France, as a member of the Eurozone, would likely call on the European Central Bank (ECB) to intervene. Although this would go beyond the ECB’s mandate, the ECB has not hesitated to intervene in bond markets and provide fiscal support to individual member states in the past.
Consequences for the EU
Whether the ECB could or would resist political pressure this time remains uncertain. Under an RN government, resistance might be more likely than under a coalition between Macron’s party and the New Popular Front. A financial crisis in France would immediately threaten the stability of the entire European financial system, providing strong economic rationale for bond purchases. However, the long-term consequences would be dire: populist fiscal policies financed at the expense of the Eurozone community could reignite the Euro crisis in a more severe form.
It’s possible that the next French government, regardless of its composition, might adopt a more moderate approach, akin to Giorgia Meloni’s actions in Italy. However, this is far from guaranteed. All of this underscores the critical importance of the upcoming elections on Sunday for the financial stability of the Eurozone.
Clemens Fuest
Professor of Economics and Public Finance
President of the ifo Institute
Published under the title “Neue Euro-Krise durch eine Machtverschiebung in Frankreich?“, Handelsblatt, July 5, 2024.