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.
