What Does France's Credit Downgrade Mean?

November 11th, 2013
in Op Ed

Written by

Standard and Poor's, the rating agency, has lowered France's credit rating on long term sovereign debt from AA+ to AA, which Finance Minister Pierre Moscovici and Prime Minister Jean-Marc Ayrault couldn't understand at all after all they have done to put France on the road to recovery.


Follow up:


Moscovici insisted his country's debt remained among the safest and most liquid in the world and criticised S&P for "inaccurate criticisms" of the French economy. He was quoted as saying:

"They are underestimating France's ability to reform, to pull itself up. During the last 18 months the government has implemented major reforms aimed at improving the French economic situation, restoring its public finances and its competitiveness."

Many would be inclined to say that the major part of the reforms have been tax increases that have got badly stuck in the popular craw, while the other reforms (of the labour market, and of the pension system) were underwhelming rather than major.

Movement, please

Still, S&P has given France a « stable » outlook. Whether that is a compliment is questionable. France needs movement bringing about change. But of course a verdict of « unstable » would have been worse. Nor is the job of the rating agencies easy. The fate of France is tied up with the fate of the Euro zone which is built on a structure that is much too rickety to withstand new storms, and serious new storms are in the offing, even if it is impossible to predict when they might break.

France is not yet in a situation where it is obvious that it will never be able to repay its sovereign debts. That does not go for Greece and Italy, probably not for Spain and Portugal. There is a European back up plan, the European Stability Mechanism, to help finance countries if they are unable to continue to finance their debt in the markets, but the funds are piffling compared with the requirements should the dam break.

Banks and governments in same boat

And then, of course, the sovereign debt and bank liabilities of the Euro zone countries have become Siamese twins. Whether it is one of he big banks or a state that go bust first doesn't make much difference in terms of the impact.

The long and the short of it is that there is a lot of debt that needs to be written off to assure the future of the Euro zone.

Is the sovereign debt of the core members of the Euro zone a riskier bet than US Treasuries, given the state of politics in Washington DC? Yes, because the USA will always be able to repay its debt, even if it repays it by debauching the currency through inflation.

That is not the case for the member states of the European Monetary Union. They no longer own the printing press, which is controlled by the European Central Bank, and the ECB is not permitted by its statutes to lend to the governments of member states (unlike the US Federal Reserve, which is pumping out $86bn a month to finance federal government debt issue). Mario Draghi has said the bank is prepared to do just that, but only with short term lending, if that is what is required to save the Euro.

More austerity not the answer When considering France's rating in isolation, the question that faces rating agencies is what they think France should and could do to improve its situation. To date it has attacked the budget deficit problem almost entirely by increasing the burden of taxes and tax-like compulsory levies.

This has done less than predicted to lower the budget deficit. It has successfully reduced domestic demand, but that was not what a doctor in his right senses would have ordered, since it was guaranteed to reduce employment and increase unemployment.

And by causing GDP growth to stagnate, the cure has brought the patient out in nasty spots when it comes to the debt to GDP ratio, soon to reach 95% of GDP

If austerity has been a mitigated success, or cannot quite be damned as an unmitigated disaster, it is far from obvious that more austerity would do France itself any good, or be to the advantage of those who invest in French sovereign debt issue.

Become more competitive

At this point in the argument, one is forced to conclude that while more austerity will not be helpful, and may only make things worse, there are a whole range of things that need to be done to make France more competitive.

The only problem with this agenda is to find the political support for any of the items on it, partly because the present government of President Francois Hollande has turned out to be weak and divided and under poor managment in the hands of Hollande himself and his prime minister, Jean-Marc Ayraut. They have failed to install enough discipline to make the government look as if it will ever be anything but a loser.

Labour market

Reform the labour market (Spain, incidentally, is showing the way)? It is badly needed, but no government dares tackle the issue head on.  The market is a dual one: those with "indeterminate" work contracts are highly protected; the rest, mainly the young, hop from one short-term job ( anything from one week to three months at a time) before finally landing an indeterminate contract, a process that often takes 10 years. An increasing share of the younger generations are taking off for places like the UK and Quebec where the labour markets are not so tightly regulated. If only France enjoyed a political culture of seeking to find common ground across the political divide for major reforms that everyone knows are necessary, as happens in Germany and many of Europe's smaller countries, progress might be made, but it's not the French way.

Labour law also supports a strongly protectionist culture towards firms that want to rationalise by reducing the payroll. The ideal is that no job should ever be abolished. A tough fight is put up again and again by the trade unions, often with the vocal support of politicians, to see that as few jobs as possible are shed, and they have the power to delay matters for years, at huge costs to the companies concerned.

It would be better, of course, is that firms are allowed to make the adjustments they consider necessary, but the labour market was so flexible that those who lose jobs can easily find another. Much would be gained if the law and culture of the land made it easier to fire and less risky to hire labour, but changing a culture as deeply embedded as France's job protection policy is near-impossible.

A government reform earlier this year has done something to ease these problems, but it is too soon to say whether they are having the desired effect.

Minimun wage

The French currently complain bitterly that these days that German social dumping is costing French jobs. Germany has no legal minimum wage and has tightened up the terms for obtaining unemployment benefit, meaning that there are now many people in very low-paid jobs, but at least they have jobs. This is causing France a lot of problems in agriculture and the food processing industries, as well as in horticulture in some regions?

France could always counter this by lowering its own minimum wage, almost €10 per hour, but there is no way that this government would or could do this and hope to survive.

Public expenditure

To tackle public sector expenditure, now amounting to about 56 % ,of GDP, a major reform of the structure of local government would be very helpful. In recent years, all efforts to contain the size of the central government have been brought to nought by the continued expansion of the local government payrolls (and taxes).

Francois Hollande promised local government reforms in his presidential campaign, but has given up the idea now he is in office. Local government reform is something that requires long and careful preparation, and, again, preferably to be carried with more support than just a narrow majority in the National Assembly.


A radical reform of the retirement pension system, which is a pay-as-you-go system by which those with jobs today pay the pensions of those who are retired today, should have been made at least 20 years ago. The demographic developments that have turned pay-as-you-go into a Ponzi system were already apparent then, but nothing has been done to adapt the system to the new situation. Instead the system has been shored up by short-term expedients, but the end result is, as will become more and more evident as each year passes, that future generations are going to receive much smaller pensions, in real terms, than recent generations.

Even minor adjustments to the system require considerable political courage. Serious structural adjustments of the system are not on the agenda.

Social Security financing

The same goes for the social security system in general, which is also based on a pay-as-you-go principle and has run into the same problems. Expenditure has continued to rise, but the revenue side has not been adjusted to keep pace. Despite effort to reverse this process, every year the system is bailed out by transfers from the central government budget.

This is another aspect of a vaunted French social model that is going bust and will soon be admitted the to the ward for terminally sick welfare systems unless costs and revenues are brought into balance.

Naturally, an economy that itself was displaying signs of good health and bounding along with rapid strides would do much to alleviate the problem. In the meantime, the politicians perform dizzying acts of political juggling in order to disguise from the population that they are actually being asked to pay more for all those "free" welfare services.

Service industries

As for deregulation of service industries, which all those worthy international economic institutions such as the European Commission, the OECD and the IMF, advocate for France, as well as Europe in general, just see what happened when the present French government hinted that it might be prepared for a spot of deregulation of the taxi system.

When it became apparent that Paris and other large cities could expect to be without taxis for a few months unless the government understood that its bright idea was a non-starter, the government, like many other governments before it, got the message. The taxis are still running.

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