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Forget About Brexit, Focus on the Euro Area Future



The Anglophone financial press is still giving prime coverage to the negotiations over Britain’s exit from the European Union. But Brexit has become a sideshow. The real economic news in Europe is being made in France and Germany, and it is of the good, potentially very good, type.

The Brexit reality has finally caught up with David Davis, the UK Secretary of State for Exiting the European Union, who quickly capitulated to all EU-27 demands on the scope and sequencing of the negotiations on the first day.

As expected, the difference in political, economic, and bureaucratic capabilities between the EU-27 under the renewed joint leadership of France and Germany, on the one hand, and the May government in London on the other is so vast that the distraction of the Brexit maneuvering should be ignored. We already know that the United Kingdom will either agree to the EU-27’s demands or suffer from damaging exit.

The outperformance of growth in the European Union this year and likely next versus most earlier growth forecasts for the European Union (and the euro area specifically) was no surprise to those of us paying attention. Macroeconomic policy remains accommodative, monetary policy a little less so, and fiscal policy a little more so, than before. More importantly, the fundamentals have kicked in. It is no longer just the German engine pushing against drags of austerity and banking system risks. The banking system is much sounder in every EU country, even Italy and Portugal, and a virtuous cycle is underway. And growth is driven internally, and not from exports, no matter what the Trump administration says. (In fact, euro area and EU net external trade has not contributed to GDP growth since mid-2015.)

And now the political capacity has turned in favor, in strong contrast to the United Kingdom and the United States. President Emmanuel Macron now has his parliamentary majority to begin overhauling the French economy. There will surely be some clashes on the streets of France in the coming months, but eventually the sclerotic French economic model will be shaken up. The En Marche parliamentary majority, who owe their jobs to Macron, is highly unlikely to be deterred by leftist unions, to whom they owe nothing. This will be good for France and noticeably for Europe. The French president will have a solid economy to back up with his credible partnership with the otherwise politically and economically dominant Germany.

Given Macron’s wide-ranging plans for a euro area budget with three specific functions (large-scale investments, financial assistance in emergencies, and countercyclical macro transfers) and for a euro area finance minister, credibility in the eyes of Angela Merkel is crucial. The recently published European Commission’s Reflection Paper is much in the same spirit and provides many of the operational details, and brings along other member states. But in the end when it comes to euro area reforms, France may propose but Germany will decide.

Meanwhile, Merkel has in recent weeks wasted no time in signaling her interest in partnering with Macron on a positive European agenda, including joint fiscal capacities. First, following the G-7 meeting in late May, she told the conservative CSU wing of her party that Germany and Europe “can no longer completely rely on others” in military and security matters, implying that German opposition to more European integration must end. Even more significantly, she also made it clear in a recent speech to the German industry association that “nein” is no longer an appropriate answer to Emmanuel Macron’s proposals for the euro area. Germany should no longer just “say what doesn’t work, but consider what could usefully work,” and a euro area budget could be possible under the right conditions.

This is an explicit conscious reversal of the attitude of the German finance bureaucracy in recent years, now that most of the legacy costs of the crisis have been contained to the members that were hit—and now that Merkel’s own historic legacy has become relevant. The fact that she is now de facto leader of the rules-based international system in the face of Putin and Trump has driven her to support more Europe.

Strikingly, here is the politically dominant German and European leader of her generation putting her own voters on notice ahead of the German elections in September that new EU integration is coming.

Recalling how Macron was explicitly elected on a platform to reform EU and euro area institutions, this is truly exciting news. There is room for a pro-European agenda that can be pursued by centrists (as one of us has also set out). What stronger indication could there be that the anti-European radicalism is past its peak than the savviest politician in Europe going to the voters that way?

With a four-year political window free of national elections after September in France and Germany (something that occurs only once every 20 years, given their election cycles), the political stars are aligning in the euro area for a major push forward for integration. This is the European economic news that you can use these days. Don’t let the Anglophone press distract you.

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