An inconvenient truth

The French have had a security wake-up call. But when it comes to the dangers facing their economy, they are still dozing

A WEEK after France was shaken by terrorist shootings in and around Toulouse, candidates for the country’s presidential election have gone back to the stump. The tone is a little less shrill, the contenders respectful of the sombre mood. Yet the return to electioneering has a surreal quality nonetheless, unlinked to the new concerns about security. For the country faces an imminent economic shock, which the presidential candidates are utterly failing to acknowledge.

The awkward truth is that France, the second-biggest economy in the euro zone after Germany, faces a public-finance squeeze. French public spending now accounts for 56% of GDP (see chart 1), compared with an OECD average of 43.3%: higher even than in Sweden. For years France has offered its people a Swedish-style social model of services, benefits and protection, but has failed to create enough wealth to pay for it.

Today France continues to behave as if it enjoyed Sweden’s or Germany’s public finances, when in truth they are closer to those of Spain. Although France and Germany have comparable public-debt levels, at over 80% of GDP, Germany’s is now inching downwards whereas France’s is at 90% and rising. One rating agency has already stripped France of its AAA credit rating over worries about high debt and low growth. The country’s auditor, the Cour des Comptes, chaired by Didier Migaud, a former Socialist deputy, has warned that unless “difficult decisions” are taken this year and next on spending, public debt could reach 100% by 2015 or 2016.

The underlying problem is that, over the past ten years, France has lost competitiveness. In 2000 hourly labour costs in France were 8% lower than those in Germany, its main trading partner; today, they are 10% higher (see chart 2). French exports have stagnated while Germany’s have boomed. An employer today pays twice as much in social charges in France as he does in Germany. France’s unemployment rate is 10% next to 5.8% in Germany—and has not dipped below 7% for nearly 30 years.

This erosion of French competitiveness raises hard questions about the underlying social compact. Frenchmen cherish the notion that everyone has an equal right to decent services in good times and a generous safety net in bad. But what sort of level of support, in sickness, joblessness, infancy or old age, can France really afford to offer its citizens? How can the country justify its massive public administration—a millefeuille of communes, departments, regions and the central state—which employs 90 civil servants per 1,000 population, compared with 50 in Germany? How can France lighten the tax burden, including payroll social charges, so as to encourage entrepreneurship and job creation?

Put simply, France is about to face the tough choices that Gerhard Schröder, Germany’s former chancellor, confronted in the early 2000s or that Sweden did in the mid-1990s, when its own unsustainable social system collapsed. The euro-zone crisis, which has made bond markets unsparing of slack economic management, means that these decisions have become both more urgent and more difficult. Whoever is elected at France’s two-round presidential election on April 22nd and May 6th will face a choice. If he fails to be tough enough on the deficit, markets will react badly, and France could find itself at the centre of a new euro-zone financing crisis. If he tackles the deficit with tax increases across the board and even spending cuts, voters will not be remotely prepared for it.

“The real risk for the euro zone now is not Greece, but France,” says a top French finance boss. Nicolas Baverez, a commentator who foresaw the country’s looming debt problems in a bestselling book of 2003, agrees: “I’m convinced that France will be the centre of the next shock in the euro zone.”

The candidates, however, are masterfully managing to duck all this. Before the Toulouse shootings intervened, the campaign turned around such pressing matters as halal slaughterhouses, immigration and tax exiles. Although both Nicolas Sarkozy, the Gaullist incumbent, and François Hollande, his Socialist rival, have embraced deficit reduction, each vowing to bring France’s budget deficit down to 3% of GDP next year, neither is promising to do so by making radical spending cuts.

Both presidential front-runners instead rely heavily on balancing the books through tax increases. Mr Sarkozy has already raised corporate and income tax. He now says he wants to tax even those who leave France for tax reasons. Mr Hollande promises a 75% top income-tax rate on those earning over €1m ($1.3m) a year, which means they would pay over 90% after social charges. He also wants to increase the annual wealth tax, levied annually on assets worth over €1.3m, and tax dividends more. He vows to raise the minimum wage, create 60,000 teaching jobs, lower the minimum retirement age to 60 for those who began work young, and “renegotiate” the European fiscal compact, a hard-won deal that seeks to guarantee budgetary discipline.

How can France be holding an election that so signally fails to confront the right questions? What are the chances that any of the candidates, if elected, is ready to face up to the shock that is to come?

pération décryptage

Many French commentators dismiss all this as mere political posturing. Aides to both front-runners argue that, in reality, each understands what is at stake. The 75% tax rate, says Olivier Ferrand, head of Terra Nova, a Socialist-linked think-tank, is “just a symbolic measure”: even Mr Hollande has conceded that it will bring in little revenue, if any. Behind all the rhetoric, Mr Ferrand insists, “the Socialist Party has modernised, and does understand the need to improve competitiveness and control the deficit.”

Mr Hollande, a jovial character in private, rejects the idea that he is dangerous, stating as much—in English—as he arrived in London in February. He has put in charge of his campaign two men, Pierre Moscovici and Manuel Valls, who were once close to the moderate Dominique Strauss-Kahn, ex-boss of the IMF, who has been ruled out of the race by a sex scandal. Once in power, French Socialists can end up doing sound things. With Mr Strauss-Khan as his finance minister, Lionel Jospin, the Socialist prime minister in 1997-2002, privatised more French companies than all his predecessors put together. “We liberalised the economy, and opened up the markets to finance and privatisation,” recalled Mr Hollande before heading to London.

et it requires much forbearance on the part of the electorate to accept that the candidate will not do half the things he has said he will. There is a serious risk of disappointment if, for example, President Hollande were to say upon taking office: “We have examined the public accounts and, quel dommage, there is no money for anything I promised after all.” And in order to defuse this risk the new president would have to put into place at least some of his dafter ideas, if only as a political gesture. The last such measure the Socialists introduced was the 35-hour working week.

Decoding Mr Sarkozy is no easier. He has now eased off on some of his more unpleasant rhetoric, but plenty more is merely disingenuous. There is already, for instance, a Schengen review under way that would allow members to suspend free movement in certain circumstances. His idea of an American-style tax on the French abroad, but only on those who have left to avoid such taxes, would be all but impossible to apply. Perhaps he knows as much, and would do none of it. Indeed, Mr Sarkozy’s friends claim that he would turn out to be a reformist president if re-elected. “Sarkozy started to campaign by calling for German-style reforms,” says one adviser. “But he realised he had no chance of winning with that, because it’s unpopular, so he has gone for rightist, populist measures instead.” In office, claims the same adviser, he would turn out to be a “very active, reformist president”.

Amid all this doublespeak, the one candidate who has consistently talked about the need for debt reduction and spending cuts is François Bayrou, a centrist. He is a perennial presidential contender, without much of a party behind him, who gets off his tractor on his Béarn farm every five years to run for office in Paris. Mr Bayrou is no liberal: he wants a “fair price” for farm produce, and proposes voting rights for unions on company boards. But he at least promises €50 billion in spending cuts (alongside €50 billion in tax increases, including a new top income-tax rate of 50%, up from 44% now). Dismissing Mr Hollande’s 75% tax rate as “crazy”, he deplores the level of political debate. “We are not asking any of the questions on which France’s future survival depends,” says Mr Bayrou. “When a country doesn’t tackle any of these questions, it runs the risk of catastrophe.” For now, though, the voters do not seem to care for this message: Mr Bayrou’s numbers are no better than Mr Mélenchon’s, which have surged to 12-13%.

Promises to break

All of which leaves voters with the unenviable task of deciphering which part of each candidate’s message is credible, and which part pure fantasy. The best guess is that both front-runners, for their own political security, would need to put in place a couple of the barmier ideas. This could be damaging enough. In 2007, after equally tough talk about immigration, Mr Sarkozy went ahead and set up a ministry of national identity—only to abolish it later on, having caused much offence along the way. Were a President Hollande to implement his 75% tax rate—just when Britain has cut its top rate from 50% to 45%—it would send an untimely message abroad about the way France treats financial success, much as the 35-hour week tarnished the country’s image for years. His overall tax policy would tell aspiring French entrepreneurs that they might be better off launching a good idea elsewhere.

The inconvenient truth is that whoever emerges the victor on May 6th will need to show a tough approach to the deficit, in the face of wary bond markets and possible recession. A President Sarkozy would need to find new budget savings, despite his promise to “protect” the French from austerity. A President Hollande would be forced to postpone or scrap some of his spending pledges, and would get a taste of German steeliness if he insisted on pushing Chancellor Angela Merkel on the subject of reviewing the fiscal compact. Either way, the result would be a shock for the French, and one that neither candidate has remotely prepared them for.