Introduction

Stiftung Wissenschaft und Politik German Institute for International and Security Affairs Comments

Economic Reforms in France WP Bleak Macroeconomic Data Is Shaking Politics in Paris and Cementing France’s

Traditional Approach towards the Economic and Monetary Union S Paweł Tokarski

With the third government since his election in May 2012, President Hollande will soon enter the second half of his term of office. He came to power with promises of economic recovery. However, the implementation of a coherent economic program quickly became an uphill battle. French voters’ persistent dissatisfaction resulted in two sound elector- al defeats of the »Parti socialiste« and record support for the »Front National«. The diffi- culties of the second largest Eurozone economy are sooner or later likely to affect the Eurozone’s stability. Why is it so hard to reform France? What does President Hollande expect from the Eurozone? And is there an acceptable way to assist French reforms?

The French economy has been severely nomic Imbalance Procedure”, the European hit by financial and economic turmoil. The Commission stated that France had been widening of the current account deficit and experiencing macroeconomic imbalances recent deterioration of the net internation- which should be properly addressed. al investment position indicate a widening On June 2, in the framework of the Euro- competitiveness gap between France and pean Semester, the European Commission northern Eurozone countries. The problems delivered a slightly more optimistic picture with the French economy are numerous: an than in 2013, but pointed out several struc- excessive and gradually increasing govern- tural problems and cast doubt over the ment spending level (one of the highest in deficit assumptions made by the govern- relation to GDP in all OECD countries, and ment for 2014 and 2015. One of the main the highest in the Eurozone); rigidity of challenges for the current and future French wages; high unit labor costs compared with governments is the growing level of general other euro area countries; and red tape. government gross debt, which reached All of this puts a heavy burden on the pri- 93.5% in relation to GDP in 2013 and is pro- vate sector, making French companies less jected to reach 95.6% in 2015. A level of debt profitable and more vulnerable to foreign higher than 85% of GDP can be a significant acquisitions than their foreign competitors. drag to economic recovery. Although the In March 2014, in an in-depth review of the costs of debt servicing decreased last year, French economy, as part of the “Macroeco- in 2013 alone the French taxpayer had to

Dr. Paweł Tokarski is an Associate in SWP’s EU Integration Divison SWP Comments 39 September 2014

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Figure 1 blow to the government’s promises, indi- Net International Investment Position of France as % of GDP cating a 0% rate of economic growth in

the first two quarters of 2014. Excluding 5 6 7 8 9 government expenses, these data show a 199 199 199 199 199 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 10 1994 contraction of the private sector, rendering 0 the previous government’s end-of-year growth forecast of 1% impossible. -10 Euro area economies are affected not -20 only by the performance of other member countries but also by the general political -30 situation. Although the so-called “phase Source: Eurostat three” economic sanctions on Russia will probably entail fewer costs for France than cover €47.3 billion in interest, as 2.3% of for other big economies of the Eurozone, the country’s GDP (according to Eurostat). the close economic relations between Paris Sluggish growth and uncertainty in the and Moscow (especially in the financial and private sector have had consequences for energy sectors) could be a source of risk if the job market. The unemployment rate, the political situation in eastern Ukraine although considerably lower than in Italy deteriorates further. or Spain, remains relatively high, especially All of these are worrying signs. The among youth (22.4% in June 2014). This is French economy – the second largest in the becoming a major predicament for the gov- Eurozone – has close trade and financial ernment and a personal one for President ties with other Eurozone members. This Hollande. During one of his first speeches raises concerns over the possible impact of after the elections he portrayed himself as economic problems in France on Eurozone the “president of the youth” and raised ex- stability, and over realistic options for the pectations among his youngest supporters current or next government majority to by promising change in the job market address these issues. situation. The slow, ongoing recovery throughout the Eurozone is only modestly apparent in Limited scope of reforms the general condition of the French econo- President Hollande won the presidential my. The most recent economic data an- elections in May 2012, when the Eurozone nounced in August 2014 were a serious crisis was still in full swing. He promised to change economic policy by reinforcing pro- Figure 2 growth policies, and to improve the situa- French GDP Volume – Percentage Change over Previous Quarter tion of the French labor market. These reform attempts were immediately 0,8 hampered by a noisy battle over the 75% in- 0,6 come tax rate for France’s richest citizens, 0,4 promised in the electoral campaign. The “tax on the rich” debate also failed to secure 0,2 popular support for the government, which -1E-15 started rapidly decreasing as the general -0,2 public demanded concrete steps to improve

the economy. -0,4 Broader reform proposals have been

-0,6 2012Q1 2012Q2 2012Q3 2012Q4 2013Q1 2013Q2 2013Q3 2013Q4 2014Q1 2014Q2 presented on several occasions as “pacts”, but these have not gone far enough to de- Source: Eurostat. liver a coherent, systemic solution to the

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Figure 3 Confidence in President François Hollande, May 2012 – September 2014

100 Lack of Confidence 80

60

40 Confidence 20 Undecided 0 May 2012 Sept. 2012 Jan. 2013 May 2013 Sept. 2013 Jan. 2014 May 2014 Sept. 2014

Source: http://www.sondages-en france.fr/sondages/Popularite/Fran%C3%A7ois%20Hollande

country’s structural problems. First, the employment tax credit), the aim of which “Pact for the Competitiveness of French is to reduce social charges for companies Industry”, prepared by a working group led by €20 billion within three years. by Louis Gallois and published in November The appointment of Manuel Valls as 2012, focused on French industry as the Prime Minister in March 2014, after the main factor of economic growth, and deliv- shocking defeat of the Parti socialiste (PS) ered a list of 22 rather diverse proposals to in regional elections, was intended to add boost competitiveness and exports. Although fuel to the reform program. He announced President Hollande had distanced himself further cuts of labor costs for the lowest- from the report even before its publication, income employees and a reduction of the some of these same ideas were included in income tax surcharge for the largest com- the “National Pact for Growth, Competitive- panies. He achieved some initial successes ness and Employment”, announced a day when the National Assembly voted for €50 later on November 6, 2012 by then Prime billion in budgetary cuts and simplified the Minister Jean-Marc Ayrault. The pact’s main country’s complex administrative structure goal was to reduce social charges for the by decreasing the number of regions. business sector, facilitating access to capital However, the rather limited scope of for small and medium-sized enterprises and the proposed measures and their slow simplifying regulations for the business implementation are unlikely to produce sector. any major effect on the French economy, The most recent (and still ongoing) especially on the labor market, before the reform measures were unveiled as part of elections in 2017. More than half of the the “Responsibility Pact”, personally an- proposed spending cuts still need to be nounced on January 14, 2014 by President specified, which could trigger an angry Hollande. This pact aims to increase em- reaction from trade unions. Therefore, the ployment in the business sector by reduc- execution of the adopted fiscal consolida- ing labor costs, company taxes and red tion program remains highly uncertain. tape. The pact was supplemented in April Moreover, the outcome of the CICE flagship by a social pillar aimed at reducing the tax project, introduced at the beginning of burden for the poorest households. The 2013, is also questionable. Limiting tax flagship project which both pacts are related reimbursement to employees earning up to to is the CICE, le crédit d’impôt pour la com- 250% of the minimum legal wage has prob- pétitivité et l’emploi (competitiveness and ably not benefited companies exporting for

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international markets, as much as it has Why is reforming France an benefited large domestic firms employing uphill battle? low-qualified workers, such as large retail History shows that skepticism regarding groups. Due to the long duration of the reform options in France is nothing new. legislative process, several measures an- Past attempts to unblock the French econo- nounced in the “Responsibility Pact”, such my abound – some of them dating back to as corporate tax cuts, are unlikely to be the early 1960s, like the report by the Rueff- introduced before the end of the current Armand Committee which proposed re- political term. inforcing competition and limiting the In addition, in August 2014 the consti- number of restricted professions. There are tutional court questioned the €2.5 billion also many other layers of resistance which reduction of social charges for the 7.4 mil- explain the difficulties of reform processes. lion lowest-income employees, which was Trade unions have traditionally played supposed to enter into force at the begin- an important role in French politics, even if ning of 2015 to further reduce labor costs. the rate of membership among employees As a result, in September the government in France (7.9%) is considerably lower than will be forced to propose compensatory in Germany (18.6%) or in the UK (26.4%). measures or agree to forego some of the Most trade union leaders have a rigid view pact’s measures. of redistributive economic policy. They are The general public in France has re- politicized and ready for noisy confronta- mained broadly skeptical towards the tion, even with the socialist government if scope of the reform agenda and its pace of they think their interests are threatened. implementation. Statements by President The culture of dialogue is clearly lacking Hollande have increasingly contradicted compared to Germany, Denmark or Sweden. macroeconomic data. In September, 77% The most recent example of this could be of the French public expressed their dis- seen on July 7 at the annual social confer- satisfaction with the measures taken by ence. Three large trade union organiza- François Hollande. The private sector tions, namely the FSU (Fédération syndicale expressed its discontent as well. At the end unitaire), CGT (Confédération générale du tra- of June, eight major employer organiza- vail) and FO (Force ouvrière), walked away tions published a letter to the president from the negotiation table refusing to sup- and the prime minister in the Journal de port the Responsibility Pact. They argued Dimanche, calling for urgent implementa- that budgetary cuts would have an adverse tion of the core measures of the Responsi- effect on the country’s economic growth. bility Pact (i.e. bringing down labor costs It seems therefore, that any ambitious struc- and the fiscal burden for the private sector, tural changes in the economy will auto- reducing red tape, and cutting public matically incite conflict with the main em- expenses). ployees’ organizations. The recent poor macroeconomic data for The main problem, however, lies in the the first two quarters of 2014 sparked an- French political class, both left and right. other wave of criticism of the president The majority of public opinion still seems and the prime minister. This constituted a to be locked into the view of an omnipotent serious blow to the government majority role of the state. Thus, while there have been just before the mid-term elections to the numerous proposals to boost economic Senate in September. The opinion polls from growth through public investments, the September show that over 80% of voters dis- need for a major revision of the role and trust the government’s economic policy. size of the government sector seems to be the primary challenge. This narrows the options in designing economic policy. For example, instead of adopting systemic

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measures, such as permanent reduction unlikely to happen any time soon, as low and simplification of taxes, temporary support for President Hollande would force measures such as the CICE are put in place, him to face cohabitation. The unpopularity adding complexity to the regulatory frame- of Hollande and growing opposition inside work. The French labor code, at almost the PS will reduce the effectiveness of the 3,500 pages long and consisting of 10,000 French executive, with possible further articles, remains a telling symbol of the government reshuffles in the future. An complexity of French legislation. Another ambitious Manuel Valls might decide not to example is the housing market. France risk his future political career by working ranks 149th out of 189 economies in regis- for a president with a record low approval tering property, which does not help to rating. It would seem, then, that increas- decrease the rigidity of the overvalued ingly unstable domestic politics in France housing market. Against this background, offer little room for any major reforms EU fiscal rules or the European Central before the next presidential and parliamen- Bank’s (ECB) monetary policy are often tary elections. presented in domestic discussions as a The main problem with traditional major obstacle to growth. The benefits of French political forces is their low cred- European integration, especially in relation ibility. In his electoral campaign in 2012 to the EU single market, are rarely men- Hollande raised high hopes among the tioned in public debates. This creates very French, to a level that his political force was fertile ground for Euroskeptic arguments unable to deliver on. He then used up the that Brussels or Frankfurt-driven economic remainder of his support by announcing policies are hampering French economic recovery in 2013 and 2014, only to be con- growth. fronted by economic indicators showing Cracks inside the ruling party do not the opposite. Yet a change of the ruling facilitate the reform task either. The coun- majority would not offer any viable alter- try’s poor macroeconomic performance will native. boost Hollande’s opponents within the Parti The position of the Union pour un mouve- socialiste. This opposition group emerged ment populaire (UMP) is even worse. The inside the PS over the vote on the €50 bil- socialists’ archrival has found itself in a lion program of cuts for 2014–2017. Further profound crisis, trapped by political scan- tensions within the PS seem inevitable, dals and financial problems, barely escap- increasing the risk for the government of ing bankruptcy. The weeks before the next losing its majority in the National Assem- UMP congress at the end of November will bly. In addition, the upcoming presidential be marked by an internal power struggle. elections are likely to cause tensions Aside from vocally criticizing the PS, none between François Hollande, Manuel Valls of the potential UMP candidates have and Arnaud Montebourg (the latter of proposed any comprehensive economic whom is the former Minister of the Econo- program. my, who came third in the PS primary The weak macroeconomic data are used presidential elections in 2011 and repre- extensively by the Front National (FN), which sents the left-wing of the PS). All are con- positions itself as an alternative to tradi- sidered potential presidential candidates of tional parties. Marine Le Pen censures both the left, and are therefore seeking support the PS and the UMP, calling them “UMPS” among the party members. Montebourg’s and claiming that they have failed to ad- open criticism forced Hollande to reshuffle dress the country’s economic problems. The the government for a second time, in a des- FN itself offers a mixture of statist and anti- perate attempt to regain political initiative. EU discourse, blaming the “Eurozone eco- The opposition is calling for the dissolution nomic policy” and the euro currency for the of the National Assembly. However, this is stagnation of the French economy and its

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continued deindustrialization. Their plans nomic government” of the Eurozone, but to introduce economic protectionism, on the other hand it has shown reserva- increase state ownership, and return to a tions towards common fiscal rules. France national currency would be disastrous from has continued its pressure on the ECB to an economic and political perspective both take measures such as asset purchases, has for France and the rest of the EU. However, warned of inflationary risks, and has de- this program, being coherent and simple, manded that Germany increase its public has found numerous supporters (including spending. In June, Hollande presented to among younger voters), and strong support the European Council his “Agenda for for the FN creates a risk that some elements Growth and Change in Europe”, which was of its economic program may be assimilat- an attempt to influence the new EU politi- ed into those of other parties. Recent polls cal cycle. The measures proposed, which indicate that a second round of presidential focused on strengthening redistribution voting in 2017 would be a duel between mechanisms at the EU level, were similar to Marine Le Pen and the UMP candidate. If those of the Compact for Growth and Jobs Nicolas Sarkozy declared his participation, and earlier socialist concepts of the late Le Pen would win the first round with 27% 1990s. Hollande called for the creation a of votes to 26% for Sarkozy. However, Marine €1.2 billion program of public investment Le Pen is viewed very negatively by French in the Eurozone, combining public and society at large, which for now makes her private sources with the Eurozone budget. unlikely to win the second round. Both France also insisted on increasing the budg- Hollande and Valls are predicted to receive et for the “Youth Guarantee” to mitigate 17% of votes each. Liberal (centrist) can- youth unemployment. According to Paris, didate, François Bayrou, who seems to offer the reinforced coordination of economic the most credible answers to the country’s policies should focus first on social and fis- economic problems, is unlikely to play a cal convergence. French calls for the crea- major role during the presidential and par- tion of “common social rights”, or the liamentary elections. creation of a minimum wage in the EU, are not new and are unlikely to raise enthusi- asm in other EU capitals. As such, these France and the EMU: should be interpreted as being aimed at old wine in a new bottle? domestic supporters of the PS, rather than Lack of success in economic policy on the a viable project aimed at increasing Euro- national level forces Paris to step up its usual zone stability. pressure on Berlin and Brussels. Already The introduction of the new EU political during his electoral campaign Hollande agenda in autumn 2014 is likely to be domi- questioned the policy of austerity and nated by further tensions concerning fiscal promised to renegotiate the “Fiscal Com- policy. In early September, French Finance pact” adopted in March 2012. However, he Minister Michel Sapin, confronted by weak had to content himself with the “Compact macroeconomic data showing the contrac- for Growth and Jobs”, which was put to- tion of the economy in the second quarter gether in two weeks, mostly relying on of 2014, confirmed that France would not renaming existing EU measures, and which meet the already extended deadline of 2015 failed to have any measurable impact on to correct the deficit. Poor GDP growth the economy. data, high levels of unemployment, lack of During Hollande’s term of office France time, and domestic obstacles to structural has failed to deliver any new narrative re- reforms are likely to increase pressure from garding the Economic and Monetary Union France and Italy on Germany to make the (EMU), sticking to its traditional, ambigu- interpretation of deficit rules more flexible. ous approach. It supported the idea of “eco- France and Italy used enigmatic wording to

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interpret the European Council’s June 26– domestic purposes in Paris and Rome, 27 conclusions, announcing that the deficit undermining the Eurozone’s credibility. rules would be treated more flexibly. To Low yields of government bonds do not increase leverage on Brussels, Hollande necessarily signal an increase of confidence mobilized socialist leaders from Europe, in the Eurozone, but rather investors’ mis- who met twice this summer in Paris before trust of economic growth perspectives. The the European Council meetings; however market’s patience will soon be tested in the political significance of this group has November, when the ECB announces bank proved limited. balance sheets results, so it is important Their primary demand is to exclude “pro- not to send too many negative signals to growth” investments from the deficit cal- financial markets. culation. Accepting this practice would be French economic problems have had two problematical, not only due to unpredict- major consequences for Germany and the able market reactions, but also due to the process of Eurozone reconstruction. First is lack of a precise definition of “pro-growth” the lack of a partner, which Berlin requires investments. In any case, a softening of the on the road to further Eurozone reforms. deficit rules would not address the main Since France and its economy are part of a problem of France and southern Eurozone problem to deal with, it is unlikely to be states, namely their inefficient, overgrown part of a constructive solution. Secondly, public sectors. On the contrary, it would France’s poor economic prospects and mis- discourage policy makers from applying trust by its citizens of the ruling majority painful cuts to the government sector, have had a considerable impact. According which are so crucial in France’s case. Fur- to the European Commission’s ‘blueprint’ thermore, a softening of fiscal rules could from November 2012, sooner or later treaty be difficult to accept, not only in Berlin but changes will be necessary to allow stricter also in countries like Poland, which has al- budgetary and economic surveillance, and ready sacrificed its private pension scheme reinforced coordination of tax and labor to comply with deficit rules. policies. A lack of domestic support for Recently, PS spokesman Olivier Faure President Hollande puts at risk any possible demanded that French military spending, revisions of the EU’s treaties aiming for due to involvement in operations abroad, deeper integration, simplification, or in- should be taken into account in the deficit creased efficiency of EMU architecture, as a calculation. This demand was already put referendum in France would likely produce forward by the Raffarin government in 2004. a ‘no’ vote. Any such revisions should be Attempts to soften EU fiscal rules are reconsidered. nothing new, as all French governments have contested them since the Stability and Growth Pact (SGP) was signed. The breach Limited options for Brussels of the SGP general government deficit and Berlin threshold in 2003 by Portugal, Germany It seems that the sustainability of the Euro- and France led to a significant watering zone will largely depend on the ability of its down of the rules in 2005. However, unlike largest economies, including France and Germany, France did not use that oppor- Italy, to successfully apply major structural tunity to reform its labor market. This time changes. The French economy is of systemic France cannot count on German support. importance for the process of Eurozone A clash over SGP fiscal rules is likely to stabilization. EU leaders cannot ignore the dominate the first half of the EU’s current economic situation in France and simply political cycle. Nevertheless, EU leaders wait for the improvement of economic con- should be careful not to fuel this conflict, ditions or a change of the ruling majority. which could serve as a useful game for However, there is no single, easy way of

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dealing with French problems at the Euro- could be faster to implement and more pean level, as most of the economic policy effective than the EU investment plan of instruments are in the hands of domestic €300 billion currently being considered, decision-makers. which would probably be largely based on There is a need for continuous pressure renaming existing EU expenses. at the governmental level from Berlin and EU leaders often overlook strong poten- other European capitals, making it clear tial for reform in the incomplete single that a further extension of the deficit dead- market. Paradoxically, the EU is the only line should only be possible on condition entity which can be successful in forcing that promised reforms go ahead. Otherwise, the southern economies to introduce some the willingness of other Eurozone countries market-oriented reforms through the ‘back to stick to deficit targets may fade, with all door’. In the past, despite strong domestic the consequences that would entail. How- resistance, several sectors in France (includ- ever, German politicians should avoid open ing transport, energy and telecommunica-

© Stiftung Wissenschaft und criticism of France, which could render the tions) have been gradually opened up for Politik, 2014 language of the French left even more con- competition in the framework of single All rights reserved frontational. market liberalization. This has benefited These Comments reflect The French government, with its very the economy and customers. Recent struc- solely the author’s views. low level of support among the public, has tural changes to the state railway system in SWP nothing to lose. Economic reforms could France, to comply with single market rules, Stiftung Wissenschaft und still be successful if focused on small steps, have shown that this can be less politically Politik German Institute for such as reducing red tape or taming budg- costly than a home-grown reform process. International and etary spending. Paris and Rome in particu- Therefore – in addition to the “Digital Security Affairs lar seem unwilling to go along with the Agenda for Europe” – a new, broader single Ludwigkirchplatz 3­4 latest proposals from Brussels on their eco- market liberalization package in the service 10719 Berlin nomic policies, which puts a question mark sector should be considered in the current Telephone +49 30 880 07-0 Fax +49 30 880 07-100 over the feasibility of planned reforms con- EU institutional cycle. The main task, how- www.swp-berlin.org tracts to be managed by the European Com- ever, is to convince the French left (which [email protected] mission. Thus, other incentives for reforms considers fiscal and social harmonization ISSN 1861-1761 at the national level could be helpful. One to be the primary objective) that the elimi- of the latest polls indicates that 70% of nation of more barriers, for example in the French voters consider the fight against EU labor market, would be beneficial for unemployment to be the most important the unemployed. goal in the government’s economic policy. Even if all of the above measures were Therefore, an extension of existing EU introduced, they would only support the mechanisms in employment policy should action plan in Paris and not replace it. be considered. This could be applied to France’s primary problem – its overgrown youth unemployment, especially among general government sector – urgently re- low-skilled workers and recent graduates. quires systemic solutions on the national The budget for the Youth Guarantee scheme level and decisive leadership in the Élysée should be increased, as demanded by Palace. François Hollande at the European Council in June. This instrument could also play a broader role as an EU tool for supporting continuous professional education and requalification in Eurozone countries with high youth unemployment, particularly among low-skilled workers, whose votes are increasingly sought after by populist forces, including the FN in France. This measure

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