Written by Hilary Barnes
When Francois Hollande (pictured), the candidate for the Socialist Party, was elected president in May this year he declared that his presidency would be a “normal’ one.
That is to say that in contrast to the presidency of his predecessor,Nicolas Sarkozy, he would pull strings behind the scenes, but his prime minister and ministerial colleagues would be responsible for running the country and would front the operation.
Brave Front on a Shaky Start
But after a shaky start in his first four months, helped along by contradictory policy statements from squabbling ministers trying to find their feet as his approval ratings plunged, Hollande appears already to be moving closer andf closer to the Sarkozy style.
In a 25-minute prime-time television appearance on September 8th, he set out to show, chin up, chest forward, none of the usual flailing of the arms, that he was in control, full of determination and with a clear plan of action for his five-year term.
A couple of days later he, and not the minister of agriculture, let the public know his plans for reinvigorating the important agricultural and agri-industrial industries.
He also kept the headline space for himself with a comment on the latest development in the life or death struggle to keep the Peugeot-Citroen auto-maker, Europe’s second biggest, from going under following the collapse of its markets in Europe.
The all-important task facing the government is, of course, the management of the economy, flat-lining this year, growth next year unlikely, even the government concedes, to be as much as one per cent, and quite possibly turning negative.
No Easy Task
A commentator like this one, before turning caustic, has to admit that Hollande’s task is exceedingly difficult, especially because the fiscal and economic policy options are narrowly circumscribed by the rules of the euro zone single currency system, which also deprives him of
monetary policy options (exchange rate devaluation is out).
If it is fair to say that Hollande has a clear idea of what he wants to do, but there are questions about the realism of his project.
The Basic Plan
His plan is to use the first two years of his term to get the budget deficit under control, restore the nation’s international competitiveness and stop surging unemployment, now about 10.2%.
The next three years will be used to build on this achievement to generate satisfactory growth in output – and a strong platform for his re-election to a second term in 2017.
The government is committed by the terms of the European Stability Pact, signed in March this year, to bring its general government budget deficit, expected to be about 4.5% this year, to 3.0% in 2013 and to zero by 2017.
The aim, of course, is to stop the growth of the budget-debt-to-GDP ratio, now just over 90%, from continuing to climb.
Avoiding the Mediterranian Syndrome
Hollande does not wish such words as “austerity” and “rigueur” to be used, as this might frighten the French into thinking that they are in for the same kind of treatment to which Spain, Greece, Portugal and Italy have been exposed, but the media reckon the fiscal tightening in store next year will be of an order “not seen since the second world war”.
You don’t have to be a Nobel Prize wining economist to have some doubts about this policy.
The first is that a strong curb on public sector demand at the same time that the private sector is in the doldrums will almost certainly cut output further and drive up unemployment. A coincidental surge in demand for France’s exports would be helpful, but the signs are not
A second is that Hollande has chosen to use an increase in taxes, especially on the rich and the business sector, as the main instrument for budget deficit reduction. The tax increases planned for 2013 come to €20bn.
Austerity for the Rich
Among them, though not the most important in terms of revenue, are his controversial proposal to put a 75% income tax rate on incomes of over €1m ($1.25m) as well as to increase the wealth tax. He has also put a three per cent tax on dividends (payable by the company) on the grounds that the money would be better used for investment.
With a programme like this, and more to come, business is not happy, and the rich and the would-be rich are wondering whether to take up residence in neighbouring European countries that have neither wealth taxes nor 75% income tax rates.
These reactions tend to confirm the correctness of the considerable body of economic research* that shows that when reducing a budget deficit raising taxes is more damaging to output and employment than budget cuts, which will play a much less important role in Hollande’s scheme of things.
The Real Fear
The real fear, however, and I do not pretend to know how realistic this fears may be, is that France will find itself in the same position as other euro zone states that have undergone the austerity treatment.
They have all started out by saying that after year or two, with forecasts to prove it, everything will be fine and dandy, but in fact output has fared much less well and tax revenues increased much less than expected.
This has put them in the situation of having to impose yet more austerity – starting a vicious circle of falling output, falling budget revenues, and rising unemployment.
“French Banks are Solid”
The “cure” has already gone far to undermining the political and social order in Greece and is now causing seriously worrying tensions between Spain’s regions and the central government, with potential Spanish mayhem to follow. France, of course, is well known for recurrent bouts
of revolutionary fervour.
In the end the success of France in avoiding austerity-driven melt down will probably be decided, as in Greece, Spain, Italy, Portugal and Ireland, by the fate of its big banks, all of them too big to fail.
“French banks are solid,” Jean-Pierre Ayrault, the prime minister, re-iterated the other day. This is only true if it assumed that they will get back all the money they have lent to Italy and Spain (they have already had to write off most of their claims on Greece).
If not – a worst-case scenario – the government would be forced to guarantee and perhaps to refinance the the banks directly, which would send the debt-to-GDP ratio into the stratosphere and shatter the triple A government debt rating.
The ECB Rescue has Three Catches
Much could hang on the European Central Bank’s plan for “unlimited” purchases of government issued debt instruments with a maturity of under five years, which is designed to keep interest rates on government debt at sustainable levels for the borrowers.
There are at least three catches.
- The first is that the eurozone’s rescue funds to do not run to bailing out both Italy and Spain, let alone France, should this need ever arise.
- Secondly, The ECB will only initiate buying for debt of countries that have agreed to conditions dictated by the European Commission in Brussels and the ECB (and perhaps the IMF). These conditions always include steep cuts in government expenditure and the implementation of measures to improve the efficiency of the economy.
Measures of both types are barely noticeable in the programme of the French government, which is essentially conservative, dedicated to preserving “the French social model” (read: welfare state) without arousing the passions of the potentially volcanic legions of France’s left-wing voters.
- Thirdly, the German Constitutional Court has put a limit oy €190bn on the funds that Germany can use to bail out troubled euro zone states without further approval by the legislature. That in effect puts a limit on the total support that will be forthcoming from all member states.
Where’s the Growth
An irony of the situation facing Hollande is that during his election campaign he said he would not sign the European Stability Pact unless it was renegotiated to include growth promoting policies.
His instinct was surely right. As a working paper** published by the Bank of France in July noted (but the French media did not, possibly because the paper is in AngloSaxon), in France over the past 100 years and more years reducing debt has only been possible in periods of
Hardly had the president met Germany’s Chancellor Angela Merkel in May than he backed down and accepted as a face saver the establishment of a European €100bn investment programme, largely cobbled together from a collection of existing programmes and given a new shiny cover.
This has not pleased all his own supporters, of whom between 20 and 30 out of 295 in the 577 seat parliament say that their hearts will not allow them to support the approval of the treaty when it come before the National Assembly in October.
Reality will probably bring their hearts into line with the urge for political survival by the time of the vote, but the defeat of the government on this crucial issue cannot be entirely ruled out.
All in all, one can only say that one wishes President Hollande the best of luck with this tricky task, but all bets off on a second term are off until further notice!
* Carlo Favero, Francesco Giavazzi, “Output effects of fiscal consolidations”, www.voxeu.com, 7 September, 2012
** Gilles Dufrénot and Karim Triki, “Why have governments succeeded in
reducing French public debt historically….” , Banque de France working paper, July, 2012.
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.