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State of the French economy

Nicole GoebelOctober 13, 2014

High debt, zero growth and weak support at home - France's leaders have their work cut out for them trying to implement much-needed reforms. DW takes a look at the state of the eurozone's second-largest economy.

Frankreich Proteste gegen Arbeitsmarktreform
Image: Reuters

The French economy is not exactly on a roll, but let's start with the bright spots. "Everybody talks about the new sick man of Europe, but France still enjoys excellent infrastructure...and a good standard of living. And during the crisis, the French economy performed much better than the UK's, for example," Diego Iscaro, senior eurozone economist at IHS Global Insight told DW.

Productivity is above the European average, levels of private debt are low, and its national debt as a share of GDP is similar to that of the UK and the US and much lower than Japan's.

In times of economic stagnation, high levels of debt are not uncommon, and there is no magic threshold at which the debt becomes unsustainable. Currently, very few countries could adhere to the EU's 60-percent threshold, as set out in the Growth and Stability Pact.

Now for the gloomy part - the International Monetary Fund (IMF) and the French government both expect 2014 growth to come in at a mere 0.4 percent - half as much as the already meager 0.8 percent forecast by the IMF for the eurozone as a whole.

In the last two quarters, French growth came in at 0 percent. Unemployment remains at above 10 percent.

France's latest budget draft effectively proposes running budget deficits well above the EU's 3-percent limit through 2017, which is very likely to be rejected in its current form by the EU Commission.

"France's budget doesn't so much stretch the fiscal rules as pretend they don't exist," Aengus Collins, lead eurozone analyst at the Economist Intelligence Unit (EIU) told DW. The EU's executive arm has the power to send back a budget for revision if the bloc's rules are violated in a significant way.

Reforms yes, but how?

On a trip to London last week, French Prime Minister Manuel Valls drew the ire of many in his Socialist Party when he told an audience in the City of London - the very heart of Europe's financial industry - that "my government is pro-business," a far cry from Francois Hollande's remark in 2012 that the finance sector is "his enemy."

Großbritannien Frankreich Manuel Valls und David Cameron
Bridging the divide - Valls is drumming up Support from EU partnersImage: Reuters/A. Winning

In terms of concrete measures, France is planning spending cuts of 50 billion euros ($63.3 billion) over the next three years, which "as a percentage of GDP… is nothing compared to the cuts in Portugal, Spain and Greece," Iscaro told DW.

French employers' federation Medef is asking for a lot more, including a lowering of the minimum wage. But given the delicate political situation within the Socialist Party, which has a strong left wing opposed to fundamental reform, incremental change is the order of the day.

In the last two years, France has "reduced social security contributions for companies," thus cutting labor costs, Gregory Claeys, a French economist and research fellow at Brussels think tank Bruegel said.

Claeys thinks the government is on a good path and that wage competitiveness with eurozone star performer Germany is one of the main issues for his country.

"Since the introduction of the euro, in Germany, labor costs have been growing much less than productivity," he says, while in France wage costs rose in line with productivity, leaving it trailing behind Germany in terms of competitiveness.

For Claeys, that means German wages will have to go up to stoke domestic demand and bring it in line with its eurozone partners.

Certainly, he says "France has to do something about wages," but he also insists that countries like Germany have to acknowledge that "in a monetary union, you cannot say that partners are on their own."

But Collins is skeptical. "The idea that France's problems could be solved by a pick-up in German demand, is stretching it too far." He believes France needs "a period of very significant reform, notably of the tax system and the labor market."

Iscaro agrees, saying that "the lack of reform in the last 10 years is now showing, it's all coming to a head."

Both say French employers need more flexibility. The 35-hour week, for example, makes it hard for employers to increase working hours or hire extra staff quickly in times of higher demand. There is also too much red tape and labor costs are too high.

Claeys, however, thinks "reform should not be just about restraining wages, but it should improve competition in the services industry, in the protected industries like pharmacies, notaries and taxi services." But resistance to reforms is high, as a recent strike by representatives of these industries has shown.

France a special case?

Germany's early-2000s Agenda 2010 reform program has often been credited with bringing the country's economy back up to speed, by restraining wage and non-wage costs among other things. While the German model cannot simply be copied, there is no reason similar reforms would not work in France, according to both Iscaro and Collins. The difference, Collins believes, is in the different mindsets.

Frankreich Apotheke
France has a large service sector with several protected industriesImage: imago/PanoramiC

"It's not so much the structure of economy, but the economic and social models that differ. The biggest issue for France will be weaning itself off an historic attachment to social provision, which is more extreme in France than in Germany. French parties are way behind the curve in having these discussions about reform," he says.

In terms of economic policy, there is very little disagreement between France's center-left and center-right parties, which is unusual elsewhere. Plus, as Claeys points out, many in France believe that countries like Germany also have to adjust and make sure their wages rise in line with productivity, so as not to drag down wages in the rest of the EU and contribute to deflationary pressure.

France's baby-steps approach is possibly the best way, and as Collins stresses, "it isn't a matter of clinging to the status quo or jumping off a neo-liberal cliff," but about "steadily loosening some of the constraints" for citizens and businesses.

The deficit issue

Iscaro, Collins and Clayes agree that the current focus on reducing France's deficit is counter-productive.

"The rigidity with which eurozone governments have sought to reduce their deficits has undoubtedly contributed to the worsening and lengthening of the bloc's economic problems," Collins says. There is bound to be some "fiscal slippage as governments seek to avoid taking too much demand out of their economies."

Clayes also points out that France has been grappling not just with structural problems, but has been hit harder on the demand side due to its close trade ties with southern neighbours Spain, Greece and Portugal, which have all had to ask for bailout help from international creditors.

Reforming the French economy is a tall order for Valls and Hollande, who are only too aware that the opinion polls paint a grim picture and that support from within the Socialist party and others is by no means guaranteed.

Whether or not the French succeed in reforming their economy will involve not just cuts and savings, but a lot of patience and the power of persuasion.