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The Decline and Fall of France

November 1, 2013 Topic: EconomicsPolitical Economy Regions: France

The Decline and Fall of France

Mini Teaser: France's ruinous economic policies could see its influence in the European Union supplanted by Germany's.

by Author(s): Milton Ezrati

FRANCE’s ECONOMY is not just doing badly. It is in profound decline. The slide has proceeded far enough now that businesspeople and politicians across the Continent increasingly refer to France as the “sick man of Europe”—quite a distinction at a moment when Greece, Portugal, Spain and Italy share the hospital ward. For decades, European Union structures were strong enough to allow Paris to ignore the country’s economic shortcomings. No longer. Unless Paris reforms its economic policies and practices, it could have a disastrous effect. Further economic woes may undermine the Franco-German cooperation on which the EU has relied, confronting the union with either dissolution or, more likely, an increasingly Germanic future.

Though recent economic reports show some slight improvement in the French economy, the underlying picture is nothing if not bleak. A monthly uptick in industrial production this spring prompted President François Hollande to declare the recession over. He was wrong. To be sure, he can now point, if he wishes, to a modest spring expansion in France’s gross domestic product (GDP). He would do well, however, to resist declaring victory over a few data points. His optimistic response to seeming industrial strength was quickly rebutted by subsequent indicators of renewed decline. He should have known that the preponderance of economic evidence remains grim and is unlikely to change anytime soon.

More than one thousand factories have closed in France since 2009. And not a week goes by without another announcement of relocations to Eastern Europe or Asia. Rates of new business formation today remain 13.3 percent lower than at the end of 2009, while business failures are 7 percent higher. The pace of home sales, though it seems to have stopped declining, shows no sign of improvement and remains 16 percent below 2008 levels. Residential real-estate prices continue to decline. Unemployment rolls have grown without interruption, recently averaging some 10.5 percent of the nation’s workforce. Youth unemployment averages over 26 percent. Real wages in France, having stagnated for some time, have declined for the last four consecutive quarters. The country’s balance of international payments continues to sink deeper into the red, with the shortfall of exports to imports almost doubling in just the past year to almost 3 percent of GDP. Government finances, too, continue in deficit, far exceeding the EU’s mandated maximum of 3 percent of the economy. Budget shortfalls over the years have brought public debt outstanding to fully 90 percent of France’s GDP.

French authorities mostly have either denied the situation’s severity or blamed it on Germany’s push for budget austerity throughout the euro zone. There is no shortage of critical remarks to make about the German approach, but it can hardly explain France’s economic problems. France, after all, hardly has imposed much austerity. It has promised to do so but otherwise has asked of itself none of the sharp government spending cuts evident elsewhere in Europe’s periphery. On the contrary, French government spending has continued to grow, rising almost 4 percent during the last two years. Government in France now constitutes some 57 percent of the entire economy, well above the euro zone’s average. Meanwhile, Paris recently sidestepped the need for more strictures, receiving permission from the EU bureaucracy to continue wider budget deficits than EU rules allow until 2015 at the earliest. Nor can French officials honestly blame German austerity when their nation’s economic slide has beginnings long before the current crisis or Berlin’s response to it. France, quite simply, has been underperforming the rest of Europe for over a decade.

It is this longer-term erosion that speaks to France’s economic failure. Germany offers a useful counterpoint. Whereas ten years ago the French economy rivaled Germany’s, today France produces only half the value added. French exports, having fallen more than 20 percent since 2005, are lower today than anytime during the last twenty years. In contrast, Germany has enjoyed an export surge in the past few years, pushing the country up from recession lows to its all-time high. France has even begun to trail Europe’s troubled periphery. While it has 10 percent fewer exporting firms than it had thirteen years ago, troubled Italy has 8.7 percent more. France’s share of global exports has fallen from 7 percent in 1999 to only 3 percent today. During this time, its share of the euro zone’s exports has fallen from 17 percent to merely 12 percent. Real per capita incomes in France have grown at barely half Germany’s rate, while profits in French industry have fallen from highs approaching 9 percent of GDP to barely over 6 percent today, only half the euro zone’s average and hardly sufficient for French industry to finance itself.

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.

Image: Pullquote: France uses the union and Germany 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.Essay Types: Essay