What if France falls?
The talk about the prognosis of the Euro, the Euro-zone, and the EU centers on Germany, Greece, Spain, and Italy these days. Nevertheless, the future of all will be determined by France. Many are calling for eurobonds, a single continent-wide finance agency, and a European bank union as the only feasible solution because it is ...
The talk about the prognosis of the Euro, the Euro-zone, and the EU centers on Germany, Greece, Spain, and Italy these days. Nevertheless, the future of all will be determined by France.
Many are calling for eurobonds, a single continent-wide finance agency, and a European bank union as the only feasible solution because it is based on community-wide sharing of risk and obligations. This seems right and those I respect most in economics and finance are proposing such measures. Yet, if France were to require a bail out a la this past weekend’s deal with Spain, none of the above would make any difference. There is simply not enough money even in Germany to bail out Spain, Italy, and France.
So the current conversation is based on the assumption that France is basically sound and that, in the end, it will be part of the solution and not part of the problem. But is that true? How sound is France?
Well, for starters, its bonds now have a 150 basis point spread over German bunds. So France is paying roughly 3 percent to Germany’s 1.5 percent. Not terrible. Not dangerous (yet), but also not as good as Germany. For the moment, France remains reasonably within most of the red lines. It’s public debt of about 85 percent of GDP, for example, is high but only a bit above Germany’s 80 percent and the EU average of 83.5 percent. But the trends are all bad and have been for some time.
Productivity has been lagging while unit labor costs have been rising steadily for ten years. As a result, according to the European Commission’s recent France Review, Paris has lost 19.4 percent of its export market share and the current account balance has fallen from a surplus of 3.2 percent of GDP to a deficit of 2.2 percent of GDP that is expected to deteriorate further to about 2.9 percent of GDP, entailing the need for further borrowing. Labor markets are rigid, unemployment high and rising, especially among for youth. Because it is so difficult to layoff a worker once hired, companies prefer to employ temps, making France’s Adeeco temp agency the primary source of youth employment. Of course, that does little for worker training and improvement of job skills. Retirement is early, public strikes frequent, and holidays plentiful.
In recent years, there were some efforts, however halting , to reverse some of these trends. President Nicolas Sarkozy actually spoke at times of following Germany’s lead in pushing out the retirement age, holding the line on wages and salaries, and keeping inflation under control. That this rhetoric bore little fruit is demonstrated by the continuation of the negative trends. But at least there seemed to be some recognition of the need for discipline and thus grounds for some hope that France and Germany might continue together to make use of the European crisis to create a more soundly integrated and revitalized Europe.
The new regime of President Francois Hollande is raising serious doubts about all that. In Italy, the rise of Mario Monti to the premier’s office was followed immediately by reforms aimed at opening up monopolies like the taxi service and achieving greater flexibility in labor markets, especially for young people. Monti also began reducing expenditures while he avoided calls for significant new taxation. Monti has been urging the Germans to accept that only austerity is not enough and that there must be measures for growth and that Germany must consume more and be prepared to lend more and to take higher inflation. But he has not denied the necessity for Italy to get its house in order.
That would be a good road for Hollande to take as well. And he could take it with less difficulty, more assurance of success, more flexibility, and more credibility with the Germans and the bond markets than Monti. But that does not appear to be the road he is taking. Yes, there is talk in Europe of Hollande having a Nixon-in-China moment, but my sources in Paris say that’s all happy talk. They are convinced that Hollande is going to do exactly what he has been saying he’s going to do. That is to raise taxes on corporations and middle and upper income families, roll back some of the extensions of the retirement age, increase the minimum wage, and essentially do nothing about the rigidity of labor markets and youth unemployment.
His hope apparently is that the increase in taxes will reduce the budget deficit while the increase in wages will stimulate spending and growth and that a virtuous cycle will ensue in which growth generates new tax revenue and further reduces debt. But it is just as, if not more, likely that the rise in taxes coupled with relaxed retirement ages and further public projects will cut growth and taxes while increasing debt. In any case, none of the tax measures will touch the problems of lack of opportunity for youth and of skilled youth emigration.
So the omens for France are not good. And if France falls, so too does the euro, and possibly the E.U. and what we have come to know as Europe as well.