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

But under the common currency and the euro zone, France has felt none of these pressures. Even as policy there has destroyed the economy’s competitiveness, the currency has stayed stable, supported by the greater economic prowess of Germany and other members. French industry has, consequently, received none of the pricing relief it would have from a falling franc. Because at the same time the euro’s constancy has sustained the wealth and buying power of the French people and the French government, neither has the country felt any restraint. Instead, the balance of payments and budget have just gone deeper into deficit, as France and its government have drawn in goods and services from elsewhere in the euro zone that its own economy no longer produces. With no pain, no constituency for reform has developed, as it would have under the franc.

So, too, the euro zone has shielded Paris from the increased credit costs. Currently, longer-term French government bonds pay a low rate of near 2.5 percent, barely over inflation. Failing economies, like France, usually pay more. Clearly lenders today feel secure that the European Central Bank will protect the euro’s value more effectively than the Bank of France would have the franc and that France, as a founding member of the EU and still its second-largest economy, is too big to fail. They believe that the rest of the union, most notably Germany, would see that its obligations are met. With lower debt-servicing costs than it would have under the franc, Paris has felt less competition within the budget for its other spending priorities, and so there is no pressure for change from this front either.

EVEN IN this latest crisis, the structure of the union has helped disguise the country’s economic failings. France’s contributions to the stability funds for the rescue of Europe’s beleaguered periphery are second only to Germany’s. But in reality, France bears disproportionately less of the cost. For one, there is the ongoing inflow France gets from the CAP. But France also benefits more than Germany and others from the relief the euro zone gives Greece, Spain, Italy and the rest of Europe’s periphery. As a proportion of total exports, France is more than twice as exposed as Germany to these countries. To the extent that EU aid supports these beleaguered economies, more of the funds loop back to France than to Germany. Meanwhile, because Germany sells almost 40 percent of its exports outside Europe altogether, it effectively provides the bulk of the outside funding for the rescue effort.

Germany’s leadership is well aware of the situation. It can surely see how France has benefited disproportionately from the union. It can also see how France has leveraged its advantages within the union and its influence there to direct more economic power than it could produce for itself. Indeed, former French president François Mitterrand, when first moving for the common currency in the 1990s, made explicit his goal to bolster French influence globally by giving France an element of political control over economic power beyond its borders. Then, of course, France’s economy stood on a par with the economy of the newly reunited Germany. As German economic power has increased and France’s has ebbed, subsequent presidents and prime ministers have refrained from such explicit renderings of French objectives. But, as should be clear, France uses the union in general and Germany in particular 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. It is inevitable that Berlin will ultimately want to free itself from such a situation and assert an influence consistent with its relative economic power, something that can only happen at Paris’s expense.

For much of the long time spent building the EU and under the euro, Berlin has resisted such an assertion. A lingering guilt from the Second World War has exerted an influence. But more fundamentally, Germany also gains from the currency union, differently than France, but significantly enough to prompt Berlin to avoid actions that might increase any centrifugal forces pulling the EU apart. There are at least two such considerations weighing on Berlin.

First, the euro has helped German industry compete globally. If the euro had never existed and Germany had continued with its deutsche mark, the huge flows of funds into Germany today would have pushed that currency’s foreign exchange value to astronomical levels, effectively pricing much German product off global markets. But because the euro encompasses other, weaker economies, its value has stayed lower than a separate deutsche mark would have, leaving Germany with an outright global pricing edge. Second, the euro’s structure has enshrined a special advantage for German business within Europe. Because Germany entered the union when its separate deutsche mark was weak relative to the country’s impressive economic fundamentals, it gave German product a distinct pricing edge, especially compared to countries in Europe’s periphery, which happened to enter the euro when their separate currencies were momentarily strong. IMF data indicate that this German pricing edge amounted to 6.0 percent when the euro was launched. Because Germany has since improved its economic fundamentals while these other countries (France and the shattered economies in Europe’s periphery) have lagged in their improvements, that pricing edge has widened to double-digit levels.

However much such considerations have restrained Berlin to date, they will not do so indefinitely. Especially as French weakness forces Germany to shoulder an increasing portion of the union’s support, Berlin should sense that it can retain the advantages of the union without having to make concessions to Paris. Indeed, the negotiations surrounding Europe’s current crisis indicate that the change is already occurring. While German chancellor Angela Merkel has tried hard to accommodate Europe in its crisis, she, unlike past German leaders, has effectively vetoed French efforts to push measures that run counter to Berlin’s interests. Germany, for instance, has steadfastly resisted French proposals for the euro zone to issue bonds jointly to finance its rescue of the periphery. Not only can Berlin see that the rescue itself benefits France disproportionately, but it also realizes that only its economic power could guarantee such pools of debt, making the bonds effectively a blank check written on Germany for common use within the euro zone. Similarly, Germany has insisted on strict euro zone–wide banking regulations before even considering plans for zone-wide relief for banks outside Germany.

Evidence of the power shift has emerged in other matters as well. Officials in Berlin, unlike in the past, refused to ignore the Germanophobic rhetoric used in a French Socialist Party working paper. German finance minister Wolfgang Schäuble angrily refuted the paper’s crass characterization of his countrymen, while Andreas Schockenhoff, a member of Germany’s socialist opposition, took his French counterparts to task for their “inappropriate” behavior. Polish foreign minister Radek Sikorski acknowledged the power shift in 2011 by calling for German leadership. That Poland, of all nations, should make such a call speaks loudly to how far the change has already progressed. A recent strategy paper produced by the Polish Institute of International Affairs has reinforced this message, explicitly citing the need for Warsaw to court Berlin because of France’s diminished ability to impact EU policies. Even Paris has all but admitted its ebbing power. By billing itself as spokesnation for the Mediterranean, it has all but admitted that acting on its own carries less weight than it once did.

Perhaps it is the recognition of this impending shift that has at last impelled France, even under the socialist Hollande, to consider policy reforms. Paris has no lack of blueprints for how to revitalize its industry and redress the political-economic balance with Germany. The most recent government-commissioned outline, authored by French business leader Louis Gallois, arrived in 2012. Last year the IMF also made explicit recommendations for French economic reform. As a sign of France’s lost stature within the EU, even the bureaucracy in Brussels has made recommendations. Paris was outraged. The various proposals all say pretty much the same things, advocating tax relief for businesses and streamlining regulations to allow more flexibility in product and especially labor markets. Gallois, speaking in terms of a “competitiveness shock,” claimed that only such measures would allow firms to adjust more effectively to market fluctuations, introduce new products and invest in new technologies to improve productivity, profitability and their competitive ability.

Remarkably, the socialist government appears to have begun to act on many of these recommendations, though matters remain horribly muddled. Under its “National Pact for Growth, Competitiveness and Employment,” Paris has introduced several initiatives. A Competitiveness and Employment Tax Credit (CICE in the French) would offer €20 billion in tax relief to companies, financed by €10 billion in general spending cuts and an increase in the VAT. An Accord National Interprofessionel (ANI) would discourage fixed-term employment contracts by placing a levy on them and help reduce youth unemployment by offering an exception to firms that hire people under twenty-six years old. The ANI would allow firms more flexibility in setting wages and hours, as well as make firing easier by allowing firms to settle their dismissal obligations with lump-sum payments and allowing only two years for employees to challenge layoffs. In return, however, it would demand that wage adjustments and changes in hours occur only to avoid layoffs and that when these occur firms help finance job mobility and training. To drive people back to work, the measure also would make extended unemployment benefits contingent on training and an active job search—what the French and other European reformers refer to as “flexicurity.” The government has also established and funded three financial vehicles to invest in research and development, higher-technology firms and what the government calls “sectors of the future.”

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