France’s leaders remain unprepared for economic calamity

By Brigitte Granville  / 

Sun, Dec 23, 2012 - Page 9

Moody’s announcement last month that it had downgraded France’s sovereign-credit rating by one notch from its “AAA” rating prompted one blogger to poke fun at rating agencies’ tendency either to get things completely wrong or to recognize suddenly a crisis that had long been staring them in the face. The blogger joked: “If this recognition by a rating agency that France has problems is an example of the first failing, a recovery must have begun; if it is an example of the second failing, the country faces a dire reckoning.”

French President Francois Hollande’s government claims to have awoken to the threat. In a recent interview, French Finance Minister Pierre Moscovici likened the measures being undertaken to reduce the country’s debt burden and restore competitiveness to a “Copernican revolution … because these choices were not clear for a French government or for a center-left government.”

As proof of this new realism, the government has been trumpeting its response to the set of policy recommendations that a panel led by the business executive Louis Gallois presented two weeks before the downgrade. The response is centered on a payroll-tax cut, which will be offset by spending cuts and a higher value-added tax.

Before the downgrade, Moody’s said that the decision would be based on whether the government heeded the Gallois report’s call for a “competitiveness shock” to France’s economy. The downgrade thus suggests that Moody’s considered the government’s response insufficient.

In fact, this negative verdict barely scratches the surface of France’s predicament.

The underlying explanation lies in the culture and prejudices of France’s governing elite, the so-called grands commis formed by the National Civil Service School of which Hollande is an alumnus. In this world, a just society requires a state-directed economy.

This dedication to dirigisme has spawned among the ruling elite a sense of entitlement and hostility to business.

Criticism of this anti-business approach is usually dismissed in France as “ultra-liberal” flailing against the “social model” that the French nation has embraced. However, the example set by Scandinavian countries, which combine a generous welfare state with pro-business policies and traditions, repudiates such claims.

The main difference between the failing French model and the more successful Scandinavian approach lies not in welfare “outputs” — many public services in France, such as the healthcare system, remain among the best in the world — but in how they are financed. The Scandinavian social compact rests on the understanding that citizens must pay high taxes in exchange for public services.

While French public spending — which stood at 56 percent of GDP last year — is at or above Scandinavian levels, French households pay lower tax rates on consumption and personal income. The gap is bridged by a mixture of deficit spending and high taxation on employment.

Relentless government borrowing and high payroll taxes (employer-paid social security) have long sustained citizens’ illusion that they are getting something for nothing, while perpetuating successive governments’ misconception that taxing business is a painless way of financing welfare and public services. However, it is increasingly apparent that this approach has undermined public finances and competitiveness — and that households end up picking up the tab. Now, citizens are facing higher taxes and cuts to public services.

Defenders of the French system quibble over labor-cost statistics in their efforts to prove that France is not so different from its main European trading partners. However, the facts of the last decade paint a different picture.

The burden of payroll taxes, together with overweening labor market regulation, stifles entrepreneurship. If Hollande’s tax hikes — on income, dividends, capital gains and capital assets — are not enough to deter entrepreneurs, the cost of hiring workers and the difficulty of firing them remain disincentives.

Far from signifying a pro-business shift, Hollande’s government’s response to the Gallois report reflects an enduring interventionist mentality. Instead of implementing deep and permanent cuts in payroll taxes on businesses, the government will give companies a 20 billion euro (US$26 billion) income-tax credit over the next two years.

And, with companies required to apply the rebated cash to investment and job creation, the government has portrayed the measure as a cut in taxes on labor that will boost employment. However, a temporary tax break cannot change incentives.

Once again, French lawmakers are acting on the conviction that they know better than market participants. Apart from promises to reduce employment regulation, the new measures boil down to officials directing state money to companies and projects of their choosing.

So the death rattle of the French economic model continues. What remains to be seen is how the end will come. And, whether it comes in the form of a capital strike by foreign bondholders, or of domestic labor strikes and wider social and political unrest, France’s leaders remain entirely unprepared for the inevitable.

Brigitte Granville is a professor of international economics and economic policy at Queen Mary, University of London.

Copyright: Project Syndicate