French election puts possibility of 'Frexit' on the agenda

14/22

The Wall Street Journal.

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Simon Nixon20 hrs ago

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© guillaume souvant/Agence France-Presse/Getty Images PARIS—What’s striking about the French presidential election is the extent to which the two front-runners share a basic analysis of the choice facing the country. Marine Le Pen, the leader of the right-wing National Front, and Emmanuel Macron, the 39-year-old former economy minister who quit François Hollande’s government to stand as an independent, are poles apart politically. But both agree that the defining issue is France’s membership of the eurozone.
Both point to the widening divergence between Germany and France’s economic performance during the past decade as evidence that the status quo isn’t sustainable. The National Front points to a recent International Monetary Fund study that suggested the euro is up to 15% undervalued in Germany and 6% overvalued in France as proof that France is at a competitive disadvantage. It argues that the only way France can remain a member of what one party official calls the “fixed eurozone exchange-rate regime” is to pursue an internal devaluation by cutting back on social protections and driving down wages. The alternative is to quit the eurozone.
Mr. Macron implicitly agrees. He wants France to stay in the euro and is campaigning for changes to the country’s public sector, welfare system and labor rules, which he says are needed to restore the country’s competitiveness. He advocates a more-flexible welfare system and labor market that protects individuals rather than jobs and allows employers to strike deals with workers at a company level rather than across sectors.
Ms. Le Pen, on the other hand, believes there is no appetite for cuts to welfare, which the National Front says provides an important economic as well as social safety net, helping to maintain household consumption. It argues that the only way to preserve the welfare system is to quit the eurozone and devalue the currency.
Of course, Ms. Le Pen’s program rests on a number of questionable assumptions. The first is that a French exit, or “Frexit,” can be managed in an orderly way. The National Front believes this is possible because under international law all government debts would be redenominated into the new national currency so there is no risk of national bankruptcy. As the fifth-largest economy in the world, it is confident that France has the clout to strike a good deal with its EU partners. There is little risk of capital flight, party officials say, because France’s post-devaluation economic prospects would be so favorable.
This will strike many as complacent. In reality, a French decision to quit the euro would likely lead to massive capital flight—and not just in France. Capital controls would likely have to be introduced across the currency bloc. France would be highly exposed to instability elsewhere via cross-border banking exposures; French banks hold nearly €300 billion ($318 billion) of Italian assets, equivalent to 10% of gross domestic product. To contain the instability, the European Central Bank would need to commit to buying assets without limits, something that it could hardly do without political cover from Berlin and other capitals, but it is hard to see this cover extending to French assets.
A second question is whether Ms. Le Pen’s policies would inspire the necessary confidence in the success of post-Frexit France. One reason why Brexit hasn’t yet had the impact that many economists predicted is that mainstream Conservatives quickly took control of the Brexit process, dumping populist Leave campaign proposals such as an extra £350 million ($436 million) a week of health spending and has instead reaffirmed the U.K.’s intention to remain an open, liberal, free-trading economy. In contrast, France’s rigid labor laws and high levels of taxation are likely to be a drag on its competitiveness regardless of what currency arrangements it might choose.
Mr. Macron’s problem is that the nuances of these economic arguments can easily be lost in an election campaign. Indeed, the resilience of the U.K. economy since the Brexit referendum can only have undermined warnings about a disorderly Frexit. Meanwhile, Mr. Macron remains vulnerable to Ms. Le Pen’s central charge that the alternative to Frexit is cutting welfare and wages. Mr. Macron’s planned announcement of his full economic plan in early March will be a crucial test for his campaign. As things stand, the manifesto is likely to be cautious and light on detail, say people familiar with his plans. Even so, his claim that he will be able to persuade Germany to deliver wider European overhauls won’t be credible unless he commits to meeting tough EU budget targets.
Mr. Macron’s hope must be that he doesn’t need to provide too much detail on his economic plans, given the way the center ground has opened up for him in the campaign, offering him a strong chance of making it to the second round. Mr. Macron may also be betting he can then go on to beat Ms. Le Pen because too many voters view her as divisive and a threat to democracy for her to win. But the risk for Mr. Macron is that under the spotlight of the campaign, even a cautious, detail-lite plan might be enough to frighten voters. Ms. Le Pen’s best chance might come if Mr. Macron were beaten into second place by Socialist candidate Benoît Hamon—a not impossible scenario, say some experienced French political observers. Faced with a choice between the hard left and hard right, it isn’t clear which way voters will jump.
Write to Simon Nixon at simon.nixon@wsj.com