“VOTRE MONSIEUR PURGON, PAR EXEMPLE, N’Y SAIT POINT DE FINESSE; C’EST UN HOMME TOUT MEDECIN, DEPUIS LA TETE JUSQU’AUX PIEDS; […] C’EST DE LA MEILLEURE FOI DU MONDE QU’IL VOUS EXPEDIERA; ET IL NE FERA, EN VOUS TUANT, QUE CE QU’IL A FAIT A SA FEMME ET A SES ENFANTS, ET CE QU’EN UN BESOIN IL FERAIT A LUI-MEME.
Take your Monsieur Purgon: he has nothing going for him. He is just a medical man from head to toe. It is in the best possible faith that he will despatch you into the next life; and in killing you he will be doing no more than he has already done to his wife and children and which, as needs be, he will also do to himself.”
«Le Malade Imaginaire, Act III, Scene 3, Moliere»
Arriving at the Gare du Nord in Paris from the Eurostar’s splendid London terminal of St Pancras – abutting the now no less splendidly restored King’s Cross – I notice that my first reflex is to hold my bag and to watch my back. This is what I used to do in the 1980s when I was travelling from Washington DC to New York City before the days of Mayor Giuliani’s “zero tolerance”. I find Paris dirty and dangerous. Where is the splendour of the ‘cité des Lumieres’? Why does the president, unlike his mentor François Mitterrand, not undertake ‘Grands Travaux’ which could make the renovation of King’s Cross pale compared to Gare du Nord. The answer of course is ‘the economy, stupid!’
France, just like Germany before the Hartz reforms, is not only the sick woman of Europe but is also slowing down the recovery of the rest of the world. The symptoms are well known: a widening competitiveness gap with Germany, posting this year a current account surplus of 8 per cent of GDP compared to France’s 2 per cent deficit, a high outstanding sovereign debt coupled with almost zero economic growth. These symptoms are relieved only by low interest rates and the ‘Draghi put’ on offer to holders of French sovereign bonds. The loss of competitiveness and resulting sharp decline in export performance has been accompanied by low corporate profit margins, constraining companies’ capacity to invest, innovate and create jobs. Last, but not least, the French national statistics INSEE reports that the unemployment rate increased 10.2 percent in the second quarter of 2014 compared to 10.1 percent in the first quarter. The International Labour Organization (ILO) reports that French unemployment rates have been about 30 per cent higher than in Germany since 1991 but this latest increase puts unemployment at one of the highest point since 1997. The unemployment rate average from 1996 to 2014 was 9.15 percent with a peak at 10.8 percent in the first quarter of 1997 and a low of 7.2 percent in the first quarter of 2008. The reasons for the economic deterioration are equally well known, and regularly set out by international organizations such as the OECD. They include the characteristics of the tax system and the way that the large welfare state and costly public services are financed.
The French business daily Les Echos quoted an American entrepreneur saying that: “In the US, taxes are levied on eggs that have been laid. In France, the hen must pay tax to get the right to lay her eggs.” The fact that there are 380 different taxes, 150 directed at enterprises and 230 at households, many of which with obscure rationales, makes the system appear unfair and arbitrary – in turn making tax compliance burdensome and tax collection costly. Balázs Égert in an OECD report notes that some taxes cost more to collect than the revenue they provide to the budget. There are numerous deductions, credits and exemptions, often without distributional grounds: for instance who can explain why foie gras should benefit from a reduced VAT rate? Another cause of uncertainty is the ceaseless changes to the already over-complicated tax system with 20 per cent of the tax code’s articles changing every year. This adversely affects both investment and saving decisions. But if everybody agrees that the tax system needs to be simplified, the task is so formidable and has been shown in the past to be so politically risky that nobody really dares to set about genuine reform.
The other principal culprit in this story of the French economy malaise is the way that the welfare state and public services are financed. Financing the welfare system by taxing labour through employers’ social security contributions and government borrowing have undermined the public finances, competitiveness, and – especially – employment for decades. The resulting deterrent to building businesses is aggravated by the phenomenon of excessive state regulation and distorting state interference at all levels of the economy. In short the bureaucratic elite trained in the National School of Administration (ENA) to serve the state have captured and suffocated France in their impenetrable web of regulations. The Scandinavian countries also have generous state welfare, but combined with pro-business policies and traditions contrary to France. The Scandinavian social compact rests on the logic that citizens must pay high taxes on income in return for good public services. But shifting the cost of social security contributions from employers to income is unlikely to have durable effects if not accompanied by productivity gains to allow for real wages to recover the loss in purchasing power over time. Therefore, in the transition period from an archaic and complex fiscal legislation to an efficient one, some replacement revenue will have to be found up front. The obvious source is to take advantage of the low interest rates now available to increase public borrowing just during the initial phase of a programme of radical structural reform. However, the Eurozone’s Fiscal Treaty does not envisage such fiscal flexibility.
“This is difficult…” is what the French President with a record low public approval rating of 13 per cent kept saying in his latest semi-annual press conference on 18 September. Indeed, the budget deficit stands at 4.4 per cent of GDP in 2014, despite the target having already been revised up earlier this year to 3.8 per cent. The Minister of Finance Michel Sapin announced that the 3 per cent deficit target will not now be hit until 2017. This is easily explained as since Mr Hollande too office, citizens face both higher taxes and public services cuts as high payroll taxes have weakened economic growth and hence the public finances. Increasing taxes at a time of deep political and economic crisis has made a bad economic situation worse. It is reminiscent of the Banque of France increasing the interest rate in 1935 to keep the gold standard while both the United States and Great Britain had already left. The economic consequences in terms of competitiveness and employment were dire.
France needs to encourage domestic demand while working at improving competitiveness: but the required supply side shock will only succeed if it appears credible mainly to the French public but also to financial markets. And the credibility required for such deep and inevitably traumatic growth-oriented reform policies to work will only be established if the reforms are undertaken in an environment that allows from the outset some monetary and fiscal flexibility designed to generate additional demand – thereby creating a pain-killing tailwind for the necessary tough reforms. Neither of those two conditions for credibility – i.e. flexibility and growth – can be met in the present straitjacket of the “rules-bound transfer union” that is the EMU. Even “straitjacket” is too passive an image. The effects of the monetary union as now constituted resemble more the lethal attentions of Molière’s quack doctor character, Monsieur Purgon.
Often the argument that the euro is irreversible is made by the political elite but, governments went off the gold standard and other fixed exchange rates arrangements. The euro is as prone to a speculative attack as any other fixed exchange rate arrangements. It is only a question of time and for how long the “Draghi put” will remain credible. As the monthly deterioration in French macroeconomic indicators shows, the ECB backstop – even supplemented now by a version of QE – will not save France. Salvation must await the end-point indicated by Molière for the Monsieur Purgon that is European monetary union in its present form – that is, it must ultimately, and in some way or other, kill itself.
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You can find more information on the Economic and Monetary Union relationship with French reforms and the possible break-up costs of the Euro on the following CGR working papers:
“The Current Eurozone – an impediment to critical French reform” By Brigitte Granville
“Conflicting incentives for the public to support the EMU” By Brigitte Granville and Dominik Nagly
cgrblog.com 