It has just been over a year since Francois Hollande was sworn in as the President of France (on May 15, 2012), but it seems he already has had enough of it. The country is in recession for the third time since 2008, the National Front – an economically protectionist and socially conservative party – has never been stronger, and he is the least popular French President since the end of World War II (according to a recent survey by the French Institute of Public Opinion) – the list could go on and on. What’s more? News of the latest recession in eurozone’s second-largest economy after Germany came exactly a year after (on May 15, 2013) Hollande took office. Well, what more could have one asked for?
For the uninitiated, the French economy contracted 0.2% quarter-on-quarter (q-o-q) in the three months to March after shrinking a revised 0.2% in the previous quarter. Fixed investment, net exports and household consumption dragged on the French GDP. The outcome was worse than widely expected, as Moody’s Analytics and the Bloomberg market consensus had both forecast a 0.1% contraction.
Even Hollande’s goal of reversing the trend in unemployment by the end of 2013 is likely to prove optimistic. The jobless rate for France rose in the three months to March to a 15-year high, while the number of French job seekers climbed for a 20th consecutive month in April to its highest level since the data series began in 1996 (as per Moody’s Analytics data). In fact, unemployment in the country has reached 3.22 million, or 10.8%, the worst since 1997. Youth unemployment rate too is hovering over 25% and is forecast to rise further next year. The reason is simple. French nominal wages are high compared with those in other eurozone nations: The labour cost per hour for enterprises with 10 or more employees is the second highest in the region. Furthermore, France’s payroll tax is among the world’s highest, discouraging companies and employers from adding staff.
No doubt, the French government had announced corporate tax breaks worth 20 billion euros in late 2012, and had agreed to some labour market reforms early this year, but these steps do not go far enough in reviving the growth. In fact, economists predict that the pace of growth will remain weak into 2014 as recent tax increases and rising unemployment weigh on activity.
Another big problem for Hollande has been the widening fiscal deficit. In fact, the country’s fiscal deficit expanded to 66.8 billion euro in April 2013 from 31 billion euro in the previous month. However, Hollande’s efforts to reduce the country’s large fiscal deficit have thus far involved increasing taxes more than cutting spending. Agrees Zach Witton, the London based Economist at Moody’s Analytics, as he tells B&E, “The French government is struggling to meet its fiscal deficit reduction targets because most of its austerity measures have relied on introducing new, and raising existing, taxes rather than much-needed sharp spending cuts thus far.” And if the trend continues, Hollande will have a tougher time going forward. Reason: New levies and higher rates on existing taxes have increased France’s tax burden, which was already one of the eurozone’s highest as a share of GDP in 2010 (according to the Heritage Foundation). Even the French government spending has reached about 57% of GDP and is the highest in the eurozone (for the past 10 years, France has had one of the highest levels of public spending in the world).
Further, President Hollande has pledged to reverse the upward trend in unemployment by the end of 2013. Recent reports suggest the government will subsidize more than half a million private sector jobs, and add hundreds of thousands of public sector jobs, this year. These measures will make it even harder for the government to reduce the fiscal deficit. Even the French government recently admitted it would fail to meet its fiscal deficit reduction target of 3% of GDP this year and was subsequently granted a two-year extension by the European Commission (on the condition that France introduce additional structural reforms).
Thus, it’s high time that France focuses on spending cuts rather than tax increase. The tax burden has already reached a very high level and any further increases in employer contributions would lead to a new deterioration in both economic activity and employment. Further, the underlying objective should not be a temporary spurt, sustained artificially by public spending, but a strong and lasting growth that creates jobs and is based on the development of modern and competitive production capacity. And that is only possible if President Hollande brings about a profound change in public policy. IMF too believes that “France should focus on cutting spending to cut the deficit rather than tax rises such as the proposed 75% rate on earnings over 1 million euros.” Interestingly, Hollande wants to levy a 75% tax on those who receive annual salaries above 1 million euros. However, the proposal has been struck down by France’s highest court.
Although Hollande recently signaled a shift toward spending cuts in 2014, vowing to stop increasing taxes on households (the government plans to reduce expenditures by 60 billion euros by 2017), previously announced tax hikes are still on track for 2014, including a rise in the main value-added tax (VAT) to 20%. The VAT for restaurants, home improvements and repairs will also jump to 10% from 7%.
Further, France’s state-funded pension system also urgently requires reform. The system is under pressure because France’s retirement age is relatively low, life expectancy following retirement has increased, and high unemployment has reduced the number of workers making contributions. France maintains a lower retirement age than most other EU nations even after the previous administration raised it from 60 to 62. Moreover, the pension system is in deficit, which the government expects to widen to 20 billion euros in 2020. In fact, pensions account for a large proportion of French government spending, and equal more than 10% of GDP, which is among the highest ratios in the eurozone.
Interestingly, in his annual letter to the French President, Bank of France Governor Christian Noyer warned that “welfare spending accounts for around 30% of GDP and the country’s social deficit path is unsustainable as it stands.” And he is right. Giving in to the temptation to keep raising social contributions leads to an increase in labour costs, which ultimately weighs on activity and jobs which in turn weigh on economic growth. Thus, the best way to deal with the problem and to bring the French economy back on track is to balance the French welfare system by bringing in some concrete reforms.
Experience suggests that Hollande will struggle to enact major reforms including pension. Opinion polls suggest many people in France want Hollande to push ahead with economic reforms but pensions are a particularly sensitive topic. Former President Nicolas Sarkozy, who undertook the last reform and raised the retirement age from 60 to 62 years, faced fierce protests, which arguably cost him re-election. Well, there is a high probability that Hollande might meet the same fate, but then, that’s the only option he has in hand if he really wants to turn France around and make it competitive again.
