A Dramatic Comeback for Europe

The unexpectedly weak performance of Geert Wilders' Freedom Party (PVV) in the Dutch election on March 15 seems to suggest this. Despite predictions running as high as 25% of the popular vote for Wilders, the PVV gained only 13%. If voters in France's upcoming presidential election prove closer to the Dutch than to Americans and Britons in their susceptibility to xenophobia and protectionism, their decision will have global implications for politics, economics, and the ideology of global capitalism.

A swing back to the center in continental Europe would strongly suggest that the unexpected victories for populist and anti-globalization movements in the US and Britain were not primarily a response to unemployment and disappointing economic performance since the financial crisis, mass migration, or the threat of Islamist terrorism. This conclusion follows from the fact that France has suffered from much higher unemployment and a longer post-crisis recession than either the US or Britain, as well as experiencing more problems with terrorism and Islamic militancy.

If German voters in the autumn follow the French and Dutch in moving back toward the political center, immigration will also be discredited as the root cause of populism. After all, Germany has experienced a much larger influx of foreigners than Britain or the US. Instead, populism will look more like an Anglo-Saxon phenomenon, motivated less by immigration and economic policy than by conservative cultural attitudes among Trump and Brexit voters and the unusual demographic alliances pitting old against young, rural against urban, and university graduates against less educated voters in the US and Britain.

The economic implications will also be far-reaching if the center holds in Europe. The European Union is a bigger trading partner than the US for most emerging economies. And the euro is the only real alternative to the dollar as an international currency. So the EU's continuing commitment to a philosophy of open trade, globalization, and carbon reduction could be sufficient to prevent a paradigm shift toward protectionism and climate-change denial that seemed almost inevitable with Trump's election.

Such a change in global leadership would require a dramatic improvement in Europe's economic performance. Fortunately, that outcome can be expected if voters reject populist politics in France and Germany. The EU has suffered a prolonged economic slump since the 2008 financial crisis, largely because the German government vetoed the kind of monetary and fiscal stimulus that helped to pull the US out of recession in 2010. Germany's veto on US-style quantitative easing was also the main reason for the near-collapse of the single currency in 2012.

But a dramatic change to European policy and economic conditions occurred in March 2015, when the European Central Bank belatedly launched a bond-buying program similar to America's, but on a far larger scale. By purchasing almost three times the total net issuance of eurozone bonds, the ECB effectively circumvented eurozone rules and began to monetize Europe's government deficits, as well as creating a mutual support system between strong economies such as Germany and weaker ones like Italy and Spain.

The ECB's actions quickly reversed the fragmentation of the European banking system and eliminated fears of a euro breakup. The immediate result was an upsurge in confidence among both businesses and consumers.

By last summer, most of Europe was already enjoying a decent recovery, when renewed fears of disintegration, this time caused by politics, not finance, suddenly overwhelmed the improvement in economic conditions. Brexit and Trump created an expectation that Europe would be the next domino to fall to populism in the looming Dutch, French, and German elections.

Of course, this possibility still cannot be dismissed, which is why international investors remain cautious about Europe. But if the populist victories that worry investors do not in fact happen, a surge of business and consumer confidence will send waves of investment flowing into the eurozone.

The key event will be the final round of the French election on May 7. If this results in a victory for Emmanuel Macron, the centrist front-runner, France will embark on a path leading to at least a modicum of economic reforms.

That, in turn, will create a much more cooperative relationship between France and Germany. Both main candidates for German Chancellor are eager to rebuild post-Brexit Europe by strengthening the Franco-German axis – and the start of a French reform process would reassure German voters that their government, by easing EU austerity, would not merely be pouring money into a bottomless pit.

This brings us to the ideological implications if centrist forces win and economic recovery accelerates in Europe this year. In the immediate aftermath of the global financial crisis, the European "social market" model of capitalism seemed like a logical alternative to the Thatcher-Reagan market fundamentalism that had broken down after 30 years of global dominance. Indeed, President Barack Obama moved the US toward greater government activism in macroeconomic management, financial regulation, environmental policy, and health care.

Paradoxically, however, Europe moved in the opposite direction. Under German pressure, the EU became the last bastion of monetarism, fiscal austerity, and the "disciplining" role of financial markets. The result was the near-fatal euro crisis of 2010-2012.

If this year's elections result in a centrist French president and a revival of Franco-German cooperation, the EU's unexpected infatuation with market fundamentalism will probably end. Europe will enjoy a better, more sustainable, and socially inclusive economic recovery than the US under Trump. If this happens, the rest of the world may again start to see the EU as a source of inspiration and a model.

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Anatole Kaletsky is Chief Economist and Co-Chairman of Gavekal Dragonomics and the author of Capitalism 4.0, The Birth of a New Economy.

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