The Rise and Fall of France - I

This daunting record has accordingly sapped any enthusiasm about France’s economic prospects. Major rating agencies—Standard & Poor’s, Moody’s and Fitch—have all downgraded the country and characterized its economy and its credit as having a “negative outlook.” The government’s own official forecast looks for tepid growth at best going forward into 2014 and 2015. The International Monetary Fund (IMF) expects negligible real growth of less than 1 percent in 2014 and not much better over the longer run. This modest projected growth is, in the grand sweep of economic history, little more than a technical difference from recession. Indeed, the basic picture is so bad that Fitch, the last agency to downgrade France, felt obliged to explain why it had not gone further, weakly citing France’s agricultural and demographic strengths. Unsurprisingly, business and consumer confidence in France have fallen to their lowest levels in years.

Rather than Berlin-imposed austerity, something clearly more fundamental is at work. As is usually the case with economic fundamentals, good or bad, the root is domestic. In France’s case, the trouble is largely of Paris’s making. Successive governments, socialist and conservative, have layered onto the economy a complex of ill-conceived policies that have hamstrung business with oppressive taxes, stultifying labor regulations, and a raft of product and production controls. These have fed on each other to sap the nation’s economic vitality, thwart efficiency, depress productivity and effort, and generally destroy the economy’s ability to compete. Compounding these problems, the country’s lavish social services seem to serve neither the taxpayers who support them nor labor’s interests—wasting a significant part of the country’s human resources.

Taxes are the most straightforward and immediate economic burden. Payroll levies in France amount to 38.8 percent, and with the added burden of business income taxes and the value-added tax (VAT), employers in France pay the government the equivalent of almost 64 percent of their payrolls. This is a much heavier weight than firms in other countries must bear. Germany, for instance, imposes a tax wedge on its business of about 53 percent, high compared to the 38.5 percent imposed by the United States, but still more than 10 full percentage points less than France. Harder to quantify but no less a burden on French business is the notorious complexity of the French tax code, which, business surveys indicate, rivals even that of the United States. Its myriad loopholes, set against the high statutory tax rates, tempt managers to divert time to tax planning that they might better dedicate to production and sales.

High individual taxes sap France’s economic dynamism in their own, less direct way. Hollande lost on his plan to tax high incomes (over €1 million a year) at an astronomical rate of 75 percent, but he still managed to drive a number of extremely productive people out of the country and sour many more. Meanwhile, Paris still imposes a 1 percent tax on certain assets, in addition to especially high taxes on dividend, interest and rent income. For those who cannot navigate the code’s complexities to find a way through one of its many loopholes, the combination of high statutory income taxes and the asset tax creates a remarkably heavy burden. The Center for Economic and Policy Research calculates that these levies rise to almost 200 percent on interest and rent income and close to 223 percent on dividend income. This is hardly a way to encourage the investment and innovation so critical to a developed economy’s competitive edge.

IF THIS tax regime were not destructive enough, France has long-standing labor rules that seem almost designed to destroy economic dynamism and efficiency. These complex regulations, itemized in the government’s 3,200-page Code du Travail, apply to any company with fifty or more workers. It speaks to the burden they impose that France today has 2.4 times the number of firms with forty-nine employees than with fifty.

The most well known of these rules is the thirty-five-hour workweek, imposed on all, however much they may want to produce. The code also imposes a minimum of five weeks paid leave, compared with three in Germany and no minimum in the United States. It requires 156 weeks parental leave, about the same as in Germany but huge compared with twelve in the United States. It limits management’s ability to alter wages and hours, and obligates companies of one thousand or more employees to place laid-off workers in new positions and train them, at the firm’s expense, for the transition, which can last between four and nine months. Until recently, employees had the right to challenge dismissal for up to five years. On average, one in four laid-off workers has done so—not a small burden on businesses. The code also imposes a mandatory retirement at age sixty—compared to an average of sixty-four in developed nations generally, according to the Organisation for Economic Co-operation and Development (OECD)—and mandates a minimum wage set at 60 percent of the median wage nationwide, high even by generous European standards.

Such regulations not only limit the flexibility and efficiency of French business, they also waste the nation’s labor resources. While mandatory early retirements strain state and private pension plans, they also deny France a pool of trained workers that in other nations still contribute actively to their economies. Government statistics show less than 20 percent of those aged sixty to sixty-four work in France, compared with more than twice that percentage in the United States and elsewhere, even in Europe. France’s shortened workweek denies the economy still more valuable labor talent, while the country’s generous unemployment benefits encourage still more to stay out of active production. Little wonder, then, that in France some 54 percent of the working-age population holds themselves outside the workforce, compared with 42 percent in Germany and 32 percent in the United States. A popular index to combine all these effects shows that France, in terms of people working and the hours each works, uses 47.4 percent of its full potential. In Germany, the figure is 50 percent; in the United States, it is 68.2 percent.

This code further burdens business by interfering with its ability to manage its own production. The expense and difficulties involved in laying off workers, adjusting wages and setting work schedules often convinces French businesses simply to forgo responses to business fluctuations that would otherwise give them a competitive edge. Worse, they prompt French industry to deny itself talent. In order to avoid the potential cost of firing, managers resist hiring despite potential business advantages. Many firms try to sidestep this problem with short-term employment contracts, some only for a period of months, so much so that fully 82 percent of new hires in 2012 involved such contracts. But this management “solution” comes with its own cost. The uncertainties of short-term employment undermine employee effort. The lack of commitment involved also dissuades firms from training. On both counts, the French economy fails to develop the pool of skilled labor that has become the hallmark of developed and modern knowledge-based economies.

Seemingly not content with these anticompetitive measures, the government has also contrived to encumber business with onerous product and production rules. Through licensing, zoning and other administrative barriers in numbers that defy cataloging here, France has discouraged economic activity across a broad front. The Heritage Foundation, taking such regulations into account, characterizes France’s business environment as only “modestly free” in its scoring of countries across the world. Nor is this all. A recent OECD study found France’s regulatory structure to be more restrictive than those of most of the developed economies that constitute the organization’s membership. France’s failings, it noted, occur in almost every major category: economic regulation, product regulation, impositions by local policies, state control of the details of business operations and barriers to entrepreneurship. The best France did was in the area of administrative regulation, and there it only matched the OECD median.

Part of the problem lies in the sheer number of governmental units that have control in France. The country’s smallest governmental unit, the commune, represents only 1,800 people on average. That compares with an EU average of 5,500 people in the smallest unit of government. This arrangement leaves France with thirty-six thousand governing entities, each setting rules and regulations, usually to suit the preferences of local business and labor interests. Thus, local shopkeepers were more successful in France than elsewhere in blocking large-scale retailers. That may have preserved a more attractive, certainly a more quaint, look to French towns and cities, but it also has denied France a trend that has become a major force for employment elsewhere in the world. It was Paris’s cooperation with such local pressure that also blocked Amazon’s effort to introduce online delivery service into the country and that thwarted attempts to allow supermarkets, as well as pharmacies, to sell over-the-counter drugs. The same sorts of interests have also steadfastly blocked efforts to increase the number of taxis in Paris, which to this day remains at the original 1924 quota.

Making matters even worse, the French government, for all the revenue it collects, seems to do less for its citizens than other countries do. The unemployed, though generously provided for, get much less help from the state finding new jobs or needed training. Paris spends only a third as much as Berlin on such direct help. In France, the average government employee assisting the unemployed with retraining and in their job search covers seventy-nine people. That compares with thirty-nine in Germany. Likewise, French schools do not prepare their charges for the job market as well as those of other countries. Recent OECD comparisons of high-school test scores show French students trailing their European and American counterparts in reading and science. The only place where the French students outscored many competitors was in math, and they still trailed the Germans. France, it would seem, is more inclined to warehouse people than help them apply themselves to economic effort.

This entire and varied weight of dysfunction has created a vicious cycle. Taxes, regulations and the loss of labor talent have so eroded profitability in French business that it has neglected its own upkeep. Again, Germany provides a handy counterpoint. During the last three years French industry has installed just over three thousand industrial robots, compared with the twenty thousand installed by German industry. Germany has spent almost 70 percent more on research and development than has France. The 2 percent of its GDP that France spends on technology investments is barely over half of the rate in Germany. This investment shortfall has interacted with France’s waste of labor talent to erode worker productivity so that even though French and German wages have moved up in tandem, the labor cost per unit of output in France has risen by 28 percent over the past ten years, compared with only 8 percent in Germany.

This destructive interaction has not just thwarted growth, but it has also begun France’s deindustrialization. Cost disadvantages have reduced industrial value added from 18 percent of the French economy in 2000 to only 12.5 percent recently, the lowest in the euro zone. French employment in manufacturing has dropped 20 percent since 2000. Meanwhile, the investment and talent shortfall has pushed what remains of the French industry increasingly toward less sophisticated products and processes. While overall manufacturing employment has dropped, employment in firms that produce unsophisticated goods and services has actually risen by 18 percent. The OECD notes that more than one-third of French manufacturing is medium- or low-tech, compared with only about one-quarter in Germany and slightly less than 25 percent in the United States. France, quite simply, is beginning to resemble a less developed economy.

FRANCE PROBABLY would have taken remedial action long ago were it not for the implicit support of the EU, the common currency and Germany. Surely it is not a coincidence that France’s greatest deterioration has occurred in the thirteen years since the adoption of the euro and the formation of the euro zone. The country’s balance of exports over imports, for instance, remained strongly positive through much of the 1990s and only began to slip into deficit in this new century. The decline in the profitability of French business also has become most evident since the inauguration of the euro, as have the slide in France’s share of global and European exports, the deterioration in French productivity and the country’s turn to less sophisticated products and processes. It is not that the currency union caused the problem. Rather, it blunted the pain France would otherwise have felt and so let matters go further than they might have otherwise.

Certainly, the EU’s common agricultural policy (CAP) has helped France otherwise live well despite its economic failings. Under this scheme, the EU budgets substantial funds to sustain food prices and ensure the profitability of agriculture. Because France’s economy has an especially large agricultural sector, the program effectively transfers funds to France from the more industrial members of the union, such as Germany. It is a major flow too. The CAP constitutes about 40 percent of the EU’s budget and is scheduled to rise to some €100 billion over the next five years. The amount that accrues to France varies from year to year, depending on which crops require the greatest price support, but EU figures show that France gets about one-fifth of the total on average, the biggest share by far. The €8 billion that would accrue, according to the EU’s latest long-term budgeting, would alone constitute almost a 0.5 percent injection into France’s economy, and it would return to France a large portion of its entire contribution to the EU budget. It is hardly surprising, then, that Hollande so violently resisted calls by British prime minister David Cameron to cut the EU budget and, by implication, the CAP as well.

The euro has allowed France to continue its competitive failings in a different way. If there were no common currency and France operated under its old franc, the declines in exports and investment flows that would accompany its economy’s competitive losses would quickly have undermined the currency’s value. The falling franc would ultimately have helped French industry compete by reducing the prices of its product in other currencies. It also would have eroded the global purchasing power of French consumers, government and business, imposing a spending discipline throughout the economy. Further, the currency losses would have increased the cost of credit, as lenders, wary of losing still more on the falling franc, would have demanded a higher rate on any loan that paid them in francs. The unavoidable burden of higher credit costs would have constrained government budgets and forced Paris to reconsider the lavish benefits it provides. Meanwhile, the pain emerging from all these strains would surely have created a strong constituency to reform the practices that led to them, one Paris could not easily defy.

But under the common currency and the euro zone, France has felt none of these pressures. Even as policy there has destroyed the economy’s competitiveness, the currency has stayed stable, supported by the greater economic prowess of Germany and other members. French industry has, consequently, received none of the pricing relief it would have from a falling franc. Because at the same time the euro’s constancy has sustained the wealth and buying power of the French people and the French government, neither has the country felt any restraint. Instead, the balance of payments and budget have just gone deeper into deficit, as France and its government have drawn in goods and services from elsewhere in the euro zone that its own economy no longer produces. With no pain, no constituency for reform has developed, as it would have under the franc.

So, too, the euro zone has shielded Paris from the increased credit costs. Currently, longer-term French government bonds pay a low rate of near 2.5 percent, barely over inflation. Failing economies, like France, usually pay more. Clearly lenders today feel secure that the European Central Bank will protect the euro’s value more effectively than the Bank of France would have the franc and that France, as a founding member of the EU and still its second-largest economy, is too big to fail. They believe that the rest of the union, most notably Germany, would see that its obligations are met. With lower debt-servicing costs than it would have under the franc, Paris has felt less competition within the budget for its other spending priorities, and so there is no pressure for change from this front either.

EVEN IN this latest crisis, the structure of the union has helped disguise the country’s economic failings. France’s contributions to the stability funds for the rescue of Europe’s beleaguered periphery are second only to Germany’s. But in reality, France bears disproportionately less of the cost. For one, there is the ongoing inflow France gets from the CAP. But France also benefits more than Germany and others from the relief the euro zone gives Greece, Spain, Italy and the rest of Europe’s periphery. As a proportion of total exports, France is more than twice as exposed as Germany to these countries. To the extent that EU aid supports these beleaguered economies, more of the funds loop back to France than to Germany. Meanwhile, because Germany sells almost 40 percent of its exports outside Europe altogether, it effectively provides the bulk of the outside funding for the rescue effort.

Germany’s leadership is well aware of the situation. It can surely see how France has benefited disproportionately from the union. It can also see how France has leveraged its advantages within the union and its influence there to direct more economic power than it could produce for itself. Indeed, former French president François Mitterrand, when first moving for the common currency in the 1990s, made explicit his goal to bolster French influence globally by giving France an element of political control over economic power beyond its borders. Then, of course, France’s economy stood on a par with the economy of the newly reunited Germany. As German economic power has increased and France’s has ebbed, subsequent presidents and prime ministers have refrained from such explicit renderings of French objectives. But, as should be clear, France uses the union in general and Germany in particular to punch geopolitically above its economic weight, to live beyond its means, and to carry on with policies and practices that it otherwise could not have sustained. It is inevitable that Berlin will ultimately want to free itself from such a situation and assert an influence consistent with its relative economic power, something that can only happen at Paris’s expense.

For much of the long time spent building the EU and under the euro, Berlin has resisted such an assertion. A lingering guilt from the Second World War has exerted an influence. But more fundamentally, Germany also gains from the currency union, differently than France, but significantly enough to prompt Berlin to avoid actions that might increase any centrifugal forces pulling the EU apart. There are at least two such considerations weighing on Berlin.

First, the euro has helped German industry compete globally. If the euro had never existed and Germany had continued with its deutsche mark, the huge flows of funds into Germany today would have pushed that currency’s foreign exchange value to astronomical levels, effectively pricing much German product off global markets. But because the euro encompasses other, weaker economies, its value has stayed lower than a separate deutsche mark would have, leaving Germany with an outright global pricing edge. Second, the euro’s structure has enshrined a special advantage for German business within Europe. Because Germany entered the union when its separate deutsche mark was weak relative to the country’s impressive economic fundamentals, it gave German product a distinct pricing edge, especially compared to countries in Europe’s periphery, which happened to enter the euro when their separate currencies were momentarily strong. IMF data indicate that this German pricing edge amounted to 6.0 percent when the euro was launched. Because Germany has since improved its economic fundamentals while these other countries (France and the shattered economies in Europe’s periphery) have lagged in their improvements, that pricing edge has widened to double-digit levels.

However much such considerations have restrained Berlin to date, they will not do so indefinitely. Especially as French weakness forces Germany to shoulder an increasing portion of the union’s support, Berlin should sense that it can retain the advantages of the union without having to make concessions to Paris. Indeed, the negotiations surrounding Europe’s current crisis indicate that the change is already occurring. While German chancellor Angela Merkel has tried hard to accommodate Europe in its crisis, she, unlike past German leaders, has effectively vetoed French efforts to push measures that run counter to Berlin’s interests. Germany, for instance, has steadfastly resisted French proposals for the euro zone to issue bonds jointly to finance its rescue of the periphery. Not only can Berlin see that the rescue itself benefits France disproportionately, but it also realizes that only its economic power could guarantee such pools of debt, making the bonds effectively a blank check written on Germany for common use within the euro zone. Similarly, Germany has insisted on strict euro zone–wide banking regulations before even considering plans for zone-wide relief for banks outside Germany.

Evidence of the power shift has emerged in other matters as well. Officials in Berlin, unlike in the past, refused to ignore the Germanophobic rhetoric used in a French Socialist Party working paper. German finance minister Wolfgang Schäuble angrily refuted the paper’s crass characterization of his countrymen, while Andreas Schockenhoff, a member of Germany’s socialist opposition, took his French counterparts to task for their “inappropriate” behavior. Polish foreign minister Radek Sikorski acknowledged the power shift in 2011 by calling for German leadership. That Poland, of all nations, should make such a call speaks loudly to how far the change has already progressed. A recent strategy paper produced by the Polish Institute of International Affairs has reinforced this message, explicitly citing the need for Warsaw to court Berlin because of France’s diminished ability to impact EU policies. Even Paris has all but admitted its ebbing power. By billing itself as spokesnation for the Mediterranean, it has all but admitted that acting on its own carries less weight than it once did.

Perhaps it is the recognition of this impending shift that has at last impelled France, even under the socialist Hollande, to consider policy reforms. Paris has no lack of blueprints for how to revitalize its industry and redress the political-economic balance with Germany. The most recent government-commissioned outline, authored by French business leader Louis Gallois, arrived in 2012. Last year the IMF also made explicit recommendations for French economic reform. As a sign of France’s lost stature within the EU, even the bureaucracy in Brussels has made recommendations. Paris was outraged. The various proposals all say pretty much the same things, advocating tax relief for businesses and streamlining regulations to allow more flexibility in product and especially labor markets. Gallois, speaking in terms of a “competitiveness shock,” claimed that only such measures would allow firms to adjust more effectively to market fluctuations, introduce new products and invest in new technologies to improve productivity, profitability and their competitive ability.

Remarkably, the socialist government appears to have begun to act on many of these recommendations, though matters remain horribly muddled. Under its “National Pact for Growth, Competitiveness and Employment,” Paris has introduced several initiatives. A Competitiveness and Employment Tax Credit (CICE in the French) would offer €20 billion in tax relief to companies, financed by €10 billion in general spending cuts and an increase in the VAT. An Accord National Interprofessionel (ANI) would discourage fixed-term employment contracts by placing a levy on them and help reduce youth unemployment by offering an exception to firms that hire people under twenty-six years old. The ANI would allow firms more flexibility in setting wages and hours, as well as make firing easier by allowing firms to settle their dismissal obligations with lump-sum payments and allowing only two years for employees to challenge layoffs. In return, however, it would demand that wage adjustments and changes in hours occur only to avoid layoffs and that when these occur firms help finance job mobility and training. To drive people back to work, the measure also would make extended unemployment benefits contingent on training and an active job search—what the French and other European reformers refer to as “flexicurity.” The government has also established and funded three financial vehicles to invest in research and development, higher-technology firms and what the government calls “sectors of the future.”

IF FRANCE were to build on such reform efforts, it could in time reestablish its own economic viability and competitive prowess and, consequently, reestablish something like the original Franco-German political-economic balance within the EU. This, obviously, is the more comfortable option for France, but also more generally. It would return the European scene to something familiar. If, however, France fails and its economy continues its relative slide—and especially if at the same time Italy, Spain and other nations in Europe’s beleaguered periphery make effective economic reforms—then the power balance will shift and the EU could change into something very different, something much more Germanic. It is too early in the game to handicap with any assurance, but probabilities at this initial stage would seem to favor the latter likelihood: less than sufficient reform in France and the more transformative future for Europe.

Certainly France cannot count on the reforms recently put in place. They are inadequate and leave many questions about Paris’s direction. Positive as they may appear, they have arrived amid much contrary maneuvering. Paris, having relieved one tax burden, has at the same time raised others. The 75 percent maximum rate failed, of course, but it has nonetheless sent a mixed message about government emphasis. Paris, by financing some corporate tax relief with a VAT hike, only burdens the economy and the companies that operate in it in a different way. Even small points muddle the message. Former French president Nicolas Sarkozy had cut the restaurant tax from 18 percent to 5.5 percent. But Hollande raised it again to 7 percent last year and has scheduled an increase to 10 percent next year. Hollande’s commitments to labor-market reform and revitalization also sound hollow given that he eagerly reversed his predecessor’s small increase in the nation’s retirement age, bringing it back from sixty-two years, still lower than the average of developed nations, to sixty years.

The reforms themselves carry a confused message. Their complexity and heavy conditions retain the heavy, top-down control of the old regulations. All the new financing vehicles set to modernize French businesses and pick “sectors of the future” are entirely controlled by the same Paris bureaucracy that created the moribund structure now in such need of reform. Even as all these new financing vehicles aim at higher technology and greater value added, the CICE gives companies tax relief only on lower-paid employees, implicitly encouraging firms to choose practices and products that favor less skilled people, and so necessarily continue the disappointing trend toward less sophisticated products and processes. In the ANI, firms get tax relief but only for some employees designated by the state in some circumstances. In order to manage their production, and so by necessity set hours and salaries, firms must commit to government-mandated employment objectives. The new rules only take from workers their old ability to question their wages because those wages are now set by a state-devised formula. Throughout, there seems to be no recognition that only a company’s managers can make it efficient and competitive.

If the French, even with their reforms, cannot rid themselves of the compulsion for state control and the root, it seems, of their economic shortcomings, then the EU’s future will have to accommodate the decline of French influence. Some associate a shrinking France with doom for the EU. Such sentiments are understandable. France, after all, was a founding member of the whole project of European unity and has been a leading light of the effort since.

But the union already has begun adjusting to a diminished French presence. Between the disproportionate returns France gets on the CAP and that accrue to it from the aid given to Europe’s periphery, it is not apparent how much of a net contribution France actually makes. Germany may already be managing economically without France. Berlin’s recent pursuit of trade agreements with China on its own speaks to its willingness to support the European experiment and, in the words of a recent Washington Post op-ed, unilaterally set an agenda for the euro zone as a whole. As indicated, Germany already has begun to veto French initiatives and write durable rules for dealing with the current fiscal-financial crisis. Others within Europe, it is evident, are accommodating themselves to Berlin’s leadership. A simple incident from earlier this year captures the sense of what is already occurring. At a meeting of finance ministers during the Cyprus troubles, it was reported that French finance minister Pierre Moscovici fell asleep and that no one at the meeting noticed until IMF head Christine Lagarde woke him. He has since denied that he actually dozed off, but even if the story is inaccurate, it nonetheless captures the developing acceptance of France’s waning role.

The change will develop slowly, certainly by the standards of the twenty-four-hour news cycle. No wars will be fought and no troops will march as in past European power shifts. The new leadership and emphasis will further avoid easy recognition by occurring entirely within the old EU forms and institutions. The greatest official violence will come from the occasional snub, as Sarkozy gave to Cameron when he refused to follow the French lead as he might have in the past and voted against Sarkozy’s proposals for Europe. Within these structures, the reality of power within the union, and certainly the euro zone, has already moved in a distinctly Germanic direction. Jacob Heilbrunn surely overstated when he wrote recently in these pages: “The past view that what was good for Germany was bad for the European Union is being supplanted by a new attitude that what is good for Germany is even better for its neighbors.” Still, he did capture the direction in which things will continue unless France can get its act together and offer a viable counterbalance. So far, there is scant evidence that France will rouse itself from its socialist sickbed. Or that it even wants to.