Europe’s rapidly unravelling economic reform agenda
Triumph of growth over austerity in Europe is leading to an economic contraction as countries attempt to bypass fiscal and structural reforms
There are many casualties of the four-year-old crisis in the euro zone.
Among the most conspicuous and troubling is the political will to implement much-needed fiscal and structural reforms aimed at raising the bloc's long-term growth rate and increasing competitiveness.
Last weekend, trenchant criticism of Germany's austerity-focused policies by Arnaud Montebourg, France's outspoken former economy minister, triggered the resignation of the country's Socialist government, led by centrist premier Manuel Valls.
Francois Hollande, France's deeply unpopular president, quickly appointed a more reform-minded government under Valls on Tuesday - even going so far as to replace Montebourg with an ex-Rothschild banker - and promised to push ahead with the controversial budgetary and labour market reforms demanded by the European Commission and Germany.
But Montebourg was speaking for many in France's ruling Socialist party when he said that Hollande's austerity policies were crushing growth and that "France shouldn't be aligning itself with the obsessions of the German right".
The lack of growth in France is making it extremely difficult to undertake the labour and market reforms that are crucial to boosting employment, reducing France's unsustainably high level of public expenditure.
Italy, which accounts for another 17 per cent of euro-zone output and has the second-largest public debt-to-gross domestic product ratio in the bloc after Greece, is in an even worse predicament.
While France's economy at least posted growth in six of the past 12 quarters, Italy has managed to register positive growth in only one quarter since the beginning of 2012 (a meagre 0.1 per cent in the final quarter of last year).
Italy has been in a more or less permanent recession since the euro-zone crisis erupted in 2010 and suffers from a much higher youth unemployment rate than France - a staggering 42 per cent compared with 24 per cent in France which, sadly, is now the average for the euro zone as a whole.
Matteo Renzi, Italy's new centre-left premier, has been just as vocal as Montebourg in his criticisms of the euro zone's rigid fiscal rules and has been pushing for a more flexible interpretation of them in order to avoid being penalised for spending more on infrastructure.
It is noteworthy that Renzi met Mario Draghi, his fellow countryman and the president of the European Central Bank, in Italy on August 12.
Ten days later, Draghi delivered the most significant speech at the central bankers' summit in Jackson Hole in the United States in which he pointed out that, within Europe's fiscal rules, there is "leeway to achieve a more growth-friendly composition of fiscal policies". He also stressed - as he does in many of his speeches - the crucial importance of structural reforms.
This suggests that euro-zone policymakers are trying to agree a quid pro quo with France and Italy: more leniency on meeting budget deficit targets in exchange for swifter implementation of structural reforms.
The problem is that the social and political backlash against economic reform in the euro zone is not just limited to fiscal austerity but encompasses the entire reform agenda - including the supply-side measures which Draghi hopes will be easier to implement if France and Italy are allowed to ease up on austerity.
While a number of vulnerable euro zone countries - in particular Spain but also Greece to some extent - have made significant headway in implementing structural and institutional reforms since the crisis erupted, France and Italy have made the least progress on this front.
The two countries' unit labour costs - the best estimate of staffing costs faced by companies - have kept rising since 2010 because of a dearth of reforms.
While France has never faced severe pressure from the bond markets, Italy was the focal point for market anxiety about the euro zone in 2011-12 and yet still failed to undertake meaningful reforms.
This does not bode well for economic adjustment in the euro zone.
Nicholas Spiro is managing director of Spiro Sovereign Strategy