French Goverment Bites the Bullet, Cuts Wage Costs
Written by Hilary Barnes
The French were hit by two heavy-weight reports on their crisis ridden economy on November 5 telling them how to get their act together.
The government of the socialist president, Francois Hollande, under blistering attacks from friends as well as foes for dithering while unemployment rises and growth stagnates, is under serious pressure to show that it is able to get a grip .
The first was a report by a home grown civil servant turned manager of state controlled companies, Louis Gallois, whose main recommendation was a "competitivity shock" in the form of hefty reductions, totalling about 1.5 % of GDP, in the wage sum taxes used to finance social welfare, this to be combined with tax increases and cuts in public expenditure.
The second came from the IMF, which called for cuts in public spending and concommitant reductions in taxation in the medium term ; loosening up of rigid labour market regulation ; and measures to ensure adequate financing for the business sector.
There are no easy solutions to France's problems, which include falling market shares in foreign and domestic markets, a shrinking manufacturing sector, low levels of profitability in companies exposed to international competition, and unemployment nearing 11 %.
Value added in manufacturing, said the Gallois report, has fallen from 18 % to 12.5 % of GDP from 2000 to 2011, while employment in manufactring has gone from 26 % of the total in 1980 to 12.6 %. Manufacturing's export market share in Europe has dropped from 12.7 % in 2000 to 9.3 %, while a surplus of €3.5bn on the balance of payments current account has soared to a deficit of €71bn and 3.5 % of GDP in the same period.
It does not matter what measures the government proposes – more taxes, cuts in public spending, more flexible labour markets - substantial sections of the population will oppose them all for one reason or another.
However on Nov 6 the government bit the bullet. It will provide a €20bn tax credit to business over each of the coming three years. It chose this measure instead of an expected cut in the payroll taxes that finance the French welfare programmes. There will be three annual tranches of ABOUT €20BN EACH (1.0% of GDP each year), which the government hopes will boost GDP by about 0.5% per year. The tax credit will enable firms to cut wage costs by about 6 % at the lower end of the wage scale and will take effect at he beginning of 2013. It will be financed by a cut in public spending by €10bn, only about 1% of the general government budget, said Prime Minister Jean-Marc Ayrault hastened reassure his public sector supporters.
The standard rate of value added tax will be increased from 19.6 to 20 % from January 1, 2014, when the v.a.t. on restaurants will go up from 7 to 10 % and possibly more. Reducing wage costs should benefit profits, but Mr Gallois went out of his way to explain that this was not his real intention, which is to increase profit margins, giving buisinesses more money to use for investment and thus generating more jobs.
Camera cuts to trade unionist, apoplectic, who obviously thought this was a demented old fashioned capitalist railroader out to bash the workers.
The latter was in line with Jean-Luc Melenchon, standard bearer are the extreme left, who denounced the Gallois report as a rehash of everything the employers have been demanding for the past few months. He also found himself in the same camp as the far right Front National leader, Ms Marine LePen, who said the report was "a collection of hackneyed ("indigent") ultra-liberal clichés."
The government is desperate to avoid doing anything that will make a serious dent in the purchasing power of consumers, hence the very minor increase proposed in the value added tax, and fears a backlash from public sector employees if it touches government expenditure. Economist Patrick Artus and team at Natixis, the investment bank, have pointed out (Oct 31, France: The best solutions) that labour market regulations make insiders (those who have jobs) so powerful that rising unemployment has very little influence on wage formation. If payroll taxes are cut, the insiders may be able help themselves to additional wages and prevent enterprises from restoring profits. The same may apply to the tax credit.
By far the best way to help French business back to health, said Natixis, would be a much more flexible labour market in which wages did react to market pressures such as rising unemployment. This would also help drive down prices in industries serving industry, which are not competitive either, see this chart from Natixis:
The IMF takes the same line, as does the European Commission. Louis Gallois kept off this subject. Francois Hollande probably dreams of more flexible labour markets, but few believe that he has much chance of winning understanding for the idea from the trade unions or important sections of his own Parti Socialist.
As for business opinion, it is shell-shocked by big tax increases totalling altogether about €27bn, either already in place or on the way, imposed by this government primarily on the wealthy and businesses. It fails to understand why, if the government thinks buinsess is not competitive, it has punished business with increased taxes in the first place.
Hilary Barnes is a veteran economics and business writer. He was for 25 years the Copenhagen Correspondent of the Financial Times, Nordic Correspondent of The Economist for part of that time, and published a paper newsletter, sold to international companies in the Nordic countries, called The Scandinavian Economies for over 30 years.