How will Europe's political economy emerge after elections?

This week our focus is on Europe and the Euro. The 17-nation currency has weathered many challenges from a banking crisis in Ireland to a real estate crisis in Spain, to continuing economic problems in Greece. But its biggest challenge may well be democracy. Its biggest test may well lie in the coming weeks, if France’s political regime post the weekend elections pits itself against Germany and its demand for fiscal discipline.

In an interview to CNBC-TV18’s Latha Venkatesh, Martin Wolf, chief economics commentator of Financial Times gives us a perspective on how the political economy of Europe will emerge after this crucial weekend elections in France and Greece.

Below is the edited transcript of the interview. Also watch the accompanying videos.

Q: If Hollande wins, are we going to see heightened political tumult between Germany and France in the weeks to come?

A: Obviously, the election in France is a very important moment. We don’t truly know what Francois Hollande will actually do. So far, it’s all been extremely vague and very much classic electioneering. My own belief is that there will be a period of turbulence in markets quite possibly because of the uncertainty.

Hollande is in fact quite conventional. He will have a traditional French view that they have to remain close to Germany. He knows that if he gets into a head-on clash with Germany, it could create a severe market crisis for French debt, he will be told that. That would be ofcourse an enormously dangerous event even from the point of view of the French economy itself. There is no possibility whatsoever of the French breaking with Germany over the Euro. So, we will discover quite soon that Hollande’s election actually makes very little difference to what is happening in the Euro zone.

Q: Yet, we are seeing opposition to austerity standards from the Dutch, continuing opposition in Greece and several other countries that also have ongoing elections. Do you think that the Euro is in danger of a break-up from any of these countries or do you think the Euro has passed it’s worst test already?

A: I agree completely that the question of the political acceptability of the austerity programmes is an absolutely fundamental one in the medium-term. There will continue to be a great deal of unrest because unemployment rates will be high and probably getting higher. It will be a very long time before economies like Spains or Greeces begin to get back to growth.
The position in the Netherlands is very different because this is an utterly sovereign country with a relatively modest temporary fiscal problem. But in the countries that are vulnerable like Spain, Greece and Portugal, possibly even Italy, though it’s much less likely, yes, there will be ongoing turmoil. It is very difficult to predict or to guess when that would get to the point that actually it is no longer manageable, but there are two flashpoints ahead.

The first is Greece because it does seem quite possible that a stable government will not emerge from the elections. It’s not clear precisely what will then happen. In the case of Spain, there is a danger that the Spain itself will fall into such a crisis that it needs a rescue programme, an official rescue programme from the other countries in the IMF. In that case, the politics could become very difficult. Possibly, though it’s unlikely since it has a large majority, the Spanish government could find it difficult to survive.

Q: Would you therefore say that 2012 could be marked by 2009 or 2011 like political brinkmanship, when there will be question marks over the survival of the Euro?

A: Yes, if the worst happens and Spain actually falls into a programme, which would then almost inevitably be a very long-term programme, in which essentially Spain would lose it’s sovereignty over its economic affairs for a long period. If that were to happen, I am not predicting it, but if that were to happen, it’s not impossible then there will be a real concern obviously in markets about another debt restructuring that’s conceivable.

It might be very difficult then to maintain stability in public debt markets and that will certainly affect the banking sectors of several countries including even Spain’s. So, the likelihood in my view, given the economic impact of the austerity and the political impact of the austerity that we will see a lot more turbulence in the next year or two.

At each stage, there will have to be an agreement to do something about this. You can never predict that this will succeed, maybe at some point they will not be able to keep all this together, keep the thing going successfully. So, I feel its turbulence ahead. They will probably manage it at each stage as they have done so far, but the crisis is certainly not over.