January 2013 newsletter – Letter from France

In recent weeks the headlines in France have been dominated by the news of the rich and famous fleeing the country to avoid the new government’s high rates of tax. In this letter, Alan Kirman looks at the difficulties faced by Francois Hollande and his colleagues in pursuing their own version of ‘austérité’.

Recent headlines suggest that France and the French Economy are coming apart at the seams. The Economist described France as ‘the time bomb at the centre of Europe’. The Herald Tribuneargued that the French had become accustomed to a life style beyond their means. This at a time of crisis in which plump and comfortably off politicians in different European countries have taken to arguing that now is the time for the less well fed and less well off citizens in European countries, particularly in France, ‘to tighten their belts’. Putting to one side the idea that this attitude may be simply the sublimation of these same politicians' dietary problems, it is worth looking at the state of the French economy and the sort of austerity measures recommended.

Much has happened in France this year, the Socialists have returned to power with Francois Hollande, the right wing opposition has gone through a sort of mirror image of what happened to the Republican party in the US. The post election battle for the leadership of the UMP, the main party of the right, was between two social and economic visions, the ‘uninhibited right’ represented by M Copé and a more centrist position occupied by M Fillon the previous prime minister. In the US, the story was that Romney was obliged to move far to the right to win the Republican primary and then shifted back to the centre to capture the votes from the centre. In France having lost the election with a fairly incomprehensible mix of anti-immigration, pro-business, but protectionist proposals, the right seems to be choosing where to place itself in the spectrum to clarify its message and to decide whether its future depends on attracting the supporters of the Front National or those in the centre. Both of the two candidates have claimed that they won the leadership election and both accuse the other of fraud. The chairman of the appeals board that decided that M Copé had won has just been condemned to a 15 months suspended sentence and 2 years of ineligibility for elected office. It might be thought that this fratricidal quarrel and the skulduggery that went with it, would have destroyed electors’ faith in the UMP. Yet, recent by-elections have shown the UMP doing well, suggesting that the honeymoon with Hollande was of short duration and that dissatisfaction with Hollande’s policies far outweighed outrage at the behaviour of the right.

Why the dissatisfaction with the current government’s policies? Clearly there was considerable dissonance between the campaign promises and the policies currently being put in place. Furthermore, there is notable variance within the government. M Montebourg, the minister for ‘Redressement productif’, has a particularly intolerant attitude to some of the foreign companies that have invested in France. He announced that he wanted nothing more to do with Mittal the Indian steel maker that threatened to close its site in the Lorraine. Boris Johnson the mayor of London quickly responded by saying that he would welcome Mittal’s activities in London. Where he envisaged putting the steel plants in London was left to the imagination. But silliness apart, there was a clear division of principle here and one which has been reflected in the recent outcry over how much tax multinational corporations pay in Europe. Are these businesses wealth creators or are they siphoning off resources only to move on as profitability declines? This is, of course a debate which is of great importance to the left-wing supporters who voted for Hollande. The government has been ambiguous. The idea of taxing firms more but to provide them with a tax credit to diminish the extra charges which are claimed to weigh French firms down was confusing for the average elector and received a tepid welcome from businesses. The basic problem is that the message to the left was an unwelcome concession to businesses whilst entrepreneurs were not happy with the idea of paying more to receive a tax credit in what amounts to two years time. The message was noisy because there is a lot of noise in the attitudes of the members of the government.

Then there was the ‘competitiveness pact’ this being an onslaught on what are thought of as the handicaps to French firms’ ability to compete in international markets. Two things are worth observing here. Firstly, it should be obvious that if competitiveness is regarded as being measured by the balance of trade then this is a zero sum game. But, of course, improving the French trade balance and becoming more competitive with the Germans for example, could be achieved in very different ways. If the burden of adjustment were to be shifted to the surplus countries then higher wages in those countries (even with the danger of more inflation of which there is no sign at the moment), then there could be an improvement with increasing activity in the French economy, still Germany’s most important trading partner. If trade balances are a zero sum game international economic activity is certainly not such a game.

But we are told that many of France’s problems are due to the fact that there are structural problems particularly in the French labour market which is not flexible enough. Yet 82 per cent of all new hires in France are on fixed short term contracts. What is surely true is that a new balance between durability of employment and the possibility of reallocating labour more effectively needs to be found. France has, in the sense I have just described, a very flexible labour market but one which bears all the marks of the old ‘insider-outsider’ debate. Secondly we are told that unit labour costs are too high in France (34.20 euros per hour, as opposed to Germany 30.10), but again this statement is too simplistic. In the manufacturing sector, the labour cost per hour in Germany is 33.37 euros per hour as opposed to 33.16 euros in France whereas the opposite is true in the service sector where Germany is clearly cheaper 26.81 v. 32.08.

In small firms, Germany has cheaper labour costs whereas in large firms, over 1000 employees, France is cheaper. But labour costs are not the whole story though many like to make this simplification. We have recently had the dispiriting privilege of a speech from Valerie Pecresse the former budget minister, who explained that a 7 per cent increase in the cost of labour (her estimate of the effect of recent legislation) would eliminate all of the 7 per cent profit margin made by French firms. She presumably believes firmly in a labour theory of value. It would however, be wrong for me to continue in this vein since the highly informed readers of this letter have heard this debate ad nauseam. However let me conclude this part of my letter by remarking that both France and Germany are way above the European average in terms of labour costs.

A slightly more subtle relation between the current crisis and economic performance is provided by the effect of growing economic inequality. Let me give a very simple or even simplistic example. One of the hardest hit sectors in France has been the car industry. To oversimplify, French cars are essentially aimed at consumers in the low and middle income sector whereas German cars target higher income consumers. One of the features of this crisis in France has been the persistent increase in income inequality.

But, this means, that with lower incomes the less well off simply demand less, hence the natural victims of this are French car manufacturers. Hence, 2012 has been one of the worst years on record for the French automobile industry. To be fair, all is not brightness elsewhere and it has to be said that BMW is also warning of a more gloomy future as the German and European economies slow. But once again, more expansionary policies which would increase the incomes of the bottom deciles would have a positive impact in both countries.

Given the increase in income inequality one might ask, what of the French attitude to the rich. The famous 75 per cent top marginal tax rate was a political gesture which as Piketty has pointed out is ineffectual given the current tax system with its complexities and all its possible exemptions. The attempt to bring taxes on capital gains and other incomes in line with those on earned income was met with howls of protest, in particular, from the ‘pigeons’, the owners of small firms. What incentive the latter asked, do they have to take risks if all their profit is to be taxed away? Yet the portrayal of these admirable entrepreneurs as the only people taking risks for the benefit of society is, as a number of economists have pointed out, hardly justified. The same argument was incidentally used to justify the payment of large bonuses to the CEOs of large banks in France not long after they had been bailed out. Somehow the appeal of the little innovators is considerable for the French and it would be foolish not to expect the latter to advance their own cause. But if the French detest the rich why are there more millionaires and billionaires in France than in any other European country according to Forbes Magazine? In any event the government quickly stepped back from its proposals to increase tax on capital gains. So, paradoxically, as Piketty indicates, it is a left wing government that has switched the ranking of taxes on earned income and capital gains.

What is holding the French government and others back from indulging in a more expansionary attitude? The answer is simple, fear of the increase in the public debt and fear of the reaction of the financial markets. But the current policies are doing little to reduce the debt, mainly because that measure is a ratio and if the denominator declines things become very difficult. Why are we afraid that the financial markets would react badly when France is borrowing at record low rates and inflation is negligible? According to recent articles in the Economist and in the Financial Times, at some point, the centime will drop and the markets will see the truth. But surely this is standing the world on its head. The same people who tell us the markets are efficient both in the technical and in a more general sense are telling us that they, journalists and commentators, see what the markets fail to perceive! We are told to listen to the markets but only, it appears, when the message coincides with what we want to hear! We have been hearing about the imminent collapse of the euro for the last year and even considerably before that and yet the exchange rate has been remarkably impervious to the oncoming disaster!

The newly ambiguous attitude of the French government and of the Banque de France towards the financial markets is interesting. A recent study has shown that the ‘financialisation’ of the French economy has contributed to national and regional income inequality. Much of the increase in the top percent of income and wealth and even more in the top tenth of a percentile has accrued to people in the financial sector. Furthermore, in most French regions income inequality did not increase very much in the period leading up to and during the crisis whilst during the crisis whilst in the Ile de France the increase was substantial and again went mainly to people in the financial sector which is concentrated in and around Paris. Hollande’s message during his campaign was very much ‘anti-finance’ but the softening of proposed bank reforms within France and the preoccupation with the attitude of the finance sector to French debt reveals a marked change in position. The recent statement by Christian Noyer the governor of the Banque de France suggesting that there is little reason to have the most important European financial centre, London, ‘offshore’ reinforces the impression that France is changing its attitude to the financial sector.

Now, with the financial markets as a pretext the French government is taking the route which many regard as having failed. The government is now practising austerity but arguing that it is not austerity. Whilst talking about improving growth prospects there is little sign of concrete measures to achieve this. To keep left wing supporters quiet and to assuage its collective conscience the government has just announced an increase in the RSA (revenue de solidarité) of 2 per cent per year for 5 years over and above the rate of inflation. This payment which amounts to a minimum of just over 400 euros per month is made to those without work or just entering employment over and above their wages. The idea due to the previous government, is to encourage a return to work. However, its effectiveness is questioned by many.

Yet, we observe a tendency, despite this sort of measure, towards more austerity. For the left it is, paradoxically, always easier to fall back on moralistic terms such as ‘rigeur’ and ‘discipline’ since these terms convey the notion of a necessary sacrifice. But, as Krugman or Stiglitz would ask, is this sacrifice necessary or even desirable? For, in the meantime, there is an obvious fraying of the social fabric in France, with youth unemployment around 25 per cent, an increase in the ‘working poor’, and over 8.6 million people below the poverty rate as measured by Eurostat, (60 per cent of median income), an increase of over a million since 2002. Over 2.5 million children live in families whose total income is below the poverty level and over 3.5 million people are without homes or living in housing which does not meet certain minimal standards. Some will argue that the inhabitants of other European countries are in an even worse situation but it is not this that concerns the average Frenchman who is much more concerned with his own comfort than that of his European neighbours. All of this, together with the dismal projections for the future should be warning signs to a government which was elected on the basis of providing their electorate with a more equitable and secure future. Liberté is holding up but égalité and fraternité are taking a knock in France.

Related resources