In his latest letter, Alan argues that the widespread view of France as an economy heading for serious trouble is based upon a very selective reading of the evidence.
A year has gone by since my last letter and little has changed. France is still, we are told, in danger of imminent economic collapse and may still bring the whole of the Eurozone down with it. Recently Standard and Poor's downgraded France's rating and the spectre of the financial markets exacting a much higher level of interest appeared yet again. ‘Ça ne peut pas continuer comme ça!’ (it can’t go on like this!’) screamed the opposition. Yet those who know France and the French are aware that this is a national battle cry and reappears before every election. (French municipal elections are to be held early next year.) Nobody specifies what it is that cannot go on as it is but, since everyone has something to complain about, it makes a convenient rallying call. Yet, you might ask, why the judgement of the rating agencies, with all their problems of moral hazard, and their contribution to the origins of the current crisis should be taken seriously? The answer apparently is that the markets heed them and will increase the interest rate they require on France’s debt. But, you might reasonably respond, why then has the most recent issue of French ten year debt been at 2.2%, close to a record low? Who has got it wrong? The economists, the press, politicians both at home and abroad or the markets? Those same markets where though faced with what was declared to be the imminent collapse of the euro, the exchange rate against the dollar is now around $1.37.
Yet, most of the people who are announcing the demise of the French economy are of the opinion that, in the end, markets should be left free and unfettered, since they will self organise into an efficient state. The current behaviour of the financial markets should then, for them, be paradoxical or is it then that as the Economist once said, the centime has not yet dropped for them. If it is the case that the markets have got it wrong and what people fear is their fierce reaction to the ‘declining’ French economy, why do the critics imagine that they themselves can anticipate this reaction correctly given the apparent incapacity of the markets to evaluate the state of the economy?
So let’s ask how does the French economy, compare with our cross channel cousins whose Chancellor has recently been crying victory?
Some telling comparisons…
On the unemployment front the U.K seems to come out an uncontested winner and some would put this down to the strength of the social safety net in France which, it is claimed, causes people to stay voluntarily out of work. Yet, this protection against unemployment is again something to which the French are attached and judging from the polls would be reluctant to weaken. But aren't the French fiscally irresponsible? Not really, since the current budget deficit in France is 4.1% and falling whereas in the U.K it is 6.4% and rising. Public debt in the U.K has now risen to over 90% of GNP and is higher than that in France. The U.K current trade deficit for 2013 will be around 4.3% while in France it will be about 1.8%. GNP growth is at a sparkling 0.8% in the U.K in the last quarter while in the same period, it shrunk by 0.1%. in France. However as the end of articles will tell you, in the third quarter of 2013 U.K. GDP was estimated to be 2.5% below the peak in the first quarter of 2008, whilst in France it is now above its lowest level. So despite the prevailing pessimism of economic pessimists France does not seem to be, at least relatively, in so much trouble.
Even in comparison with Germany, things are not as bad as they are made out to be. The productivity of French workers is only marginally different from and, if anything, superior to that of German workers. Unemployment is undoubtedly the Achilles heel but it does not seem likely that reducing labour costs in order to improve competitivity is the answer despite the claims of the MEDEF, the French employers organisation. French unemployment has a very special structure which means that there is very little mobility among the long term unemployed and all the action is taking place with those with short term contracts. How this could be addressed might be the subject for another Letter from France. Certainly, from the French point of view, a more expansionary policy in Germany would be useful and increasing labour cost and stimulating demand there could do no harm to France nor to German workers, since France is still Germany's biggest trading partner. Nevertheless the overall French position is not totally negative.
…ignored by Standard and Poors
Unfortunately the distinctly wobbly positions taken by Francois Hollande have done little to reassure the French and the critical voices of foreign experts have found a ready ear in some quarters and this has magnified the dark mood of many of the French. Unfortunately the distinctly wobbly positions taken by Francois Hollande have done little to reassure the French and the critical voices of foreign experts have found a ready ear in some quarters and this has magnified the dark mood of many of the French.
But what was the argument the rating agency gave? ‘The French government's current approach to budgetary and structural reforms to taxation, as well as to product, services and labor markets, is unlikely to substantially raise France's medium-term growth prospects.’ It is curious that many of the people who have finally been convinced that financial markets left to their own devices do not self organise into an optimal state, still insist that we should maintain this credo for other markets.
But most of the structural reforms in question are addressed to those markets. They are those that would be dictated by the economic theory that has failed us so miserably in the current crisis. But, although many economists agree that we need to re-examine our theory and our macroeconomic theory in particular, few seem ready to make the logical step to reconsidering the prescriptions for economic reform that stem from it. But it is not things at this level which upset most economic commentators. Rather, is the failure of the French to to make cuts in government expenditure and instead to envisage increases in taxes. As Piketty and others have suggested, more courageous would have been not to conform to the rules and simply to increase expenditure but this would have required a very different attitude than that displayed by this government.
The real motives
What is the solution proposed when structural reforms are evoked? In general it is to make the labour market more ‘flexible’, by which is meant to reduce labour costs, thereby making the nation more ‘competitive’. France is viewed as being particularly bad since it is ranked very high in the OECD, Employment Protection, league table! How should this rigidity be reduced? In France, it is suggested, the first target would be to cut the overhead charges which go to pay for the extensive and, by the critics’ criteria, over generous safety net. The second is to reduce wages either by extending the working week or not adjusting with inflation although the latter at 0.7% is hardly rampant. Thus those who are unemployed and leading a comfortable life, according to those who decry them, could be made sufficiently miserable to oblige them to take the jobs that they had previously chosen to refuse. So those unemployed who now found a job would be less happy, and those who did not even more so. France's ranking in terms of lower employment would certainly improve. But, since, presumably the object is to increase the general welfare this does not seem the obvious way to go. Increasing taxes to pay for the safety net and increasing public expenditure would, for those currently unemployed, seem to be a better solution whilst the better off would find it less so. Yet this ancient debate depends on how the economy responds to such measures.
Philippe Aghion was quick to declare, in response to Krugman in Le Monde, that we have solid evidence that increasing taxes undermines growth. Yet, is the evidence so clear? Having got beyond the usual examples of Sweden and Canada, it does not seem so obvious. In fact, if there is real public agreement on one thing in France, it is that expenditure on the health system, for example, should not be cut. Although we are constantly being told that the French are being crushed by their fiscal burden the figures do not bear this out and there seems to be a willingness to contribute more rather than see the system partially dismantled. The ‘real tax burden’ in France is lower than that in Belgium and higher than that in Germany but the differences do not seem to be enough to have a major impact on employment. Nevertheless various pressure groups in France have demonstrated recently against tax increases particularly the so-called ‘ecotax’ on fuel, introduced for environmental reasons, which it is claimed will drive Brittany farmers and road transport firms out of business.
These groups appeal to the public by claiming that everyone feels that the government is holding a fiscal knife to their throat and that they are just the latest victims. Furthermore the parties to the right manage to frame things in such a way as to fan the flames. Given the worsening results of France in the PISA estimates of scholastic achievement, the government declared, not unreasonably, that it was going to employ more teachers. The response was to say, ‘our schools are going downhill and all that they can think of is to employ more fonctionnaires’ (teachers are civil servants in France). Yet, most people would accept that there is some economic benefit to be extracted from increased investment in education but a little change in the framing has an effect. Nevertheless, although this sentiment seems to have resonated with some, it does not seem to have generated that overall pessimism which some claim to perceive.
Indeed, Francois Hollande has seen his popularity slide to record lows. Yet, putting this down to France's economic woes is too easy. What have been the major issues in France? First it was the legalisation of gay marriage which brought hundreds of thousands of pro and anti demonstrators out into the streets. These were not the scenes of philosophical debate but ones of quite remarkable violence at times. The second and most recent source of agitation has been the passing of a law introducing fines for the clients of prostitutes along Swedish lines. There is room for perfectly reasonable differences of opinion on this, but the fact is that it overshadowed discussion of economic problems for a period. There are those who suggest that the government deliberately brought these issues to the fore in order to distract attention from the economic disaster they had wrought. But, given the way the current government handles affairs, this attributes more Machiavellian skill to its members than is warranted.
In the light of all this are the gloomy predictions about France's future justified? It is clear that the major problem is unemployment and although France is better than the EU average in this respect it still trails Germany, for example, by a considerable margin. Again a positive contribution to this would be a more expansionary German economic policy, which might start a virtuous upward circle. But, even in a world where more and more policymakers are becoming worried that inflation is too low, the legacy of the distant past stills weighs heavily and Germany is not yet ready to subscribe to this view.
In this respect, many are worried by the recent decline in German industrial production and fear that the much heralded Eurozone recovery may be stillborn and this would indeed be bad news for France. But France like the other Eurozone countries is still hobbled by the Maastricht rules. Most of the economic policies being adopted, in European countries, have at least one eye on these rules. Yet how did the countries involved come to agree to fixed debt and deficit levels independent of the current state of the European economies? Why 3%? The man in the street must find it difficult to believe that the number 3 has any special significance.
But what are the reasons, based on the work of economists, used to justify the fierce insistence on the Maastricht criteria. Two argument have been that if public debt goes above 90% there is a dangerous inflexion point at which growth drops off sharply, yet as all the readers of this letter know, the work of Carmen Reinhart and Ken Rogoff frequently cited in this context was subject to flaws and there is no evidence for such an inflexion point. That the general argument that there is a correlation between rising debt and slower growth remains on the table, is clear but not with any direction of causality and not with any specific and dangerous threshold. What the homme dans la rue could reasonably ask is why the economists at the IMF, the European Union, in government departments such as the INSEE in France were not asked at least to verify the analysis on which economic recommendations were based? Would we conduct a large scale vaccination campaign on such a basis, and yet, even if we did, the consequences would probably be considerably less harmful.
Again, when Olivier Blanchard and Daniel Leigh, indicated that the fiscal multiplier had been seriously underestimated, their argument was probably too subtle for the policy makers who had used the previous estimates as an argument for austerity. Nevertheless, the latter should have taken as much note of the corrections as of the original numbers and should have been chastened. It does not appear to have been the case.
So, tied down by the restrictions imposed by the EU, France has little room for manoeuvre. There are a few promising signs however. The government has just introduced a policy which provides everyone in the labour force with a capital of further training or education which can be used over a life time. As the changes in skills required occur rapidly this should encourage the upgrading of skills and more mobility between sectors. In fact, this may, in the long run, turn out to be more effective than the much vaunted apprenticeship schemes, which produce highly qualified but narrowly specialised workers.
Another positive sign is that fertility is high with French women having more than 2 babies and generating population growth. Their German counterparts however, seem to be much less optimistic and are the least prolific baby producers in Europe and by 2060 the French population is forecast to have increased by 13.5% whilst the German population will have decreased in almost exactly the same proportion. This means that the problem facing many developed countries, an aging and declining population and an increasingly heavy pensions burden will not be one which France has to face.
Has it then been the case that this has been a year in which an increasingly pessimistic attitude has emerged as the French economy, according to outside observers, has drifted steadily towards the rocks? As I have said, the markets do not share this view, nor apparently do the French people as they are busily producing offspring. Even if it is not the case that ‘Tout est pour le mieux dans le meilleur des mondes possibles’, at least it does not seem that the déluge is about to arrive.