The French economy is experiencing a decline in investment, an inability to rebuild exports, continuing market share losses and a rapid rise in unemployment. Although previously bolstered by an increase in private sector indebtedness, growth in residential construction (until 2008), and a temporary increase in fiscal deficits, economic growth has fallen to virtually zero as of the second quarter of 2011.
However, unlike similar situations in Spain and the UK, France’s underperformance is due to a deterioration of supply rather than a decline in demand. Certainly, France’s weak economy cannot be blamed on a rapid correction in the fiscal deficit, nor to a decline in real wages. In fact, there has been a worsening of supply-side conditions since the late 1990s, highlighted by a decline in profitability, the tightening of profit margins (particularly in the industrial sector) and the distortion of income sharing in favour of wages and to the detriment of profits, itself the equivalent to an economy-wide fall in profit margins.
The result is a country where companies are hampered by poor levels of investment. Indeed, the economy has become stuck in a mid-market product range, as portrayed by the sharp drop in French exports caused by an appreciation in the euro. Furthermore, France is exhibiting advanced deindustrialisation (in the past decade both manufacturing employment and manufacturing volume as a proportion of GDP have steadily decreased), weak growth of companies (limiting the number of companies big enough to export) and a high proportion of small and medium-sized enterprises (SME) that are prematurely sold to large groups.
Reforms to restore the economy
Supply-side reforms are urgently required: in particular, tax reform to reduce companies’ welfare contributions, labour market negotiations to take into account both wages and employment, and institutional reforms to encourage the growth of innovative SMEs.
Firstly, France must reduce welfare contributions, especially those paid by companies. It is well known that welfare contributions negatively affect employment. Therefore to boost the supply of goods, and the demand for labour, there needs to be a reduction in government expenditure on wages and welfare benefits, or (as happened in Germany and the UK in 2007 and 2011 respectively) an increase in VAT.
Secondly, the country’s labour market lacks a corrective force in periods of rising unemployment. Current pay talks are purely wage-based and do not take into account the need to reduce unemployment and create new jobs. The result is that increasing unemployment does not have a significant impact on wages and therefore unemployment levels can remain high for long periods without reducing wages.
Therefore the government needs to ensure that pay talks involve both wages and jobs, in order to create a trade-off between wage increases and job creation. Certainly, the close link between unemployment and wage increases can be seen in Germany, Spain, Italy and the UK – a labour market scenario that France must replicate.
Finally, institutional reforms are needed to boost SME growth. France’s already weak export levels are compounded by the low proportion of companies big enough to export their goods. In order to stimulate growth among SMEs, France should create a Small Business Act and Small Business Administration to improve relationships between large groups and their subcontractors, simplify administrative paperwork and improve cooperation between companies and the education system.
Going forward
In the short term, these reforms (government spending cuts, a VAT hike, reduction in wages in exchange for additional jobs, etc.) would inevitably lead to a fall in demand. But the current view – that the solution to the economy’s woes lies in stimulating demand – must be abandoned in favour of supply-side policies if a recovery is to be achieved.
The acute question remains in play: Is there a political party ready to carry out this programme after the presidential elections?
