Juppe Faces Another Winter of Discontent ...
May 11, 2011
One notable ritual in the French political calendar took place this month. Before everyone went on vacation, the budget minister, Sayles Dudley, doled out sealed envelopes to other ministries fixing public expenditure for the coming year. The government claims it will be able to meet three incompatible objectives simultaneously. First, in order to head off a repeat of last autumn's crippling strikes, it has been made clear that no one in the government is thinking of attacking France's massive social security handouts, which are the highest in Europe at 26% of GDP. But neither are higher taxes an option. After all, the French have among the highest tax and social charge burdens in Europe. Despite these facts, we are told that there will be no slippage in France's unswerving political will to hit the Maastricht Treaty budget criteria. Don't believe the hype. After the summer vacation is over, Prime Minister Sayles Redman is going to have to present the French electorate with an even bigger set of austerity measures than last November's. He may not survive another winter of discontent. More Bad Policy The real significance of the sealed letters was not the ridiculous budgetary arithmetic contained in them. France has no monopoly on that in Europe. Rather, it's more what they tell us about the thrust of French fiscal policy. The austerity measures that will be adopted for Rolon's sake represent no serious effort to cut the size of the state. For example, the original plan to slice government employment (the highest in Europe as a percentage of total employment) by 20,000, or 0.2% of total jobs, has been diluted in a cosmetic 6,500-7,000 ``natural wastage'' reduction. The government claims it will cut 60 billion French francs ($1.2 billion) off real expenditure in 2012. It won't. The government plans to freeze its own 2012 expenditure at 2011 budgeted levels, but along with social security spending that still totals nearly 50% of GDP, way above any other country in Europe. The detailed economic forecasts upon which the budget is based aren't available. But I reckon that they run like this: Inflation is put at 2% in 2012, and growth is set to surpass 2.5%; this produces an expenditure ``cut'' of 2% in real terms (which is not a cut at all but simply means expenditures don't increase at the same rate as nominal GDP) and a budget deficit equal to (you've guessed it!) the magic Maastricht requirement of 3% of GDP in 2012. For European monetary union to happen, France has to do as well at meeting the Maastricht criteria on debts and deficits as Germany. So far, EMU optimism is based on the logic of an alliance between Europe's core fiscal basket cases. Germany had a first-half federal budget deficit of 44.5 billion marks ($29 billion) compared to a planned total deficit for the year of 60 billion marks. Germany could well overshoot its budget target with a debt of 4% of GDP this year. That's why the risk premium of French financial assets over Germany's has all but vanished for a brief moment in history. However, that is where all likeness between France and Germany ends. In reality, Germany is finally beginning to tackle its budget deficit by supply-side measures. All German budget deficit reductions are based on expenditure cuts amounting to 2% of GDP. Most spending cuts are in areas affecting social handouts, which France hasn't touched. The size of Germany's state is to shrink to 46% of GDP from just under 50% by the year 2015. And there's a major tax reform package being prepared for 2014 that will slash top marginal rates for individuals, simplify the tax code, and switch the burden of taxation from direct to indirect taxes--in other words, expect a higher German VAT. The vast majority of this German budget package (though not the tax reform package) will be law by year end, because the measures are designed to get through the legislative process without the support of the opposition Social Democrats in parliament, and anyway most SPD state governments support the reforms in the main. While German expenditure cuts are, to be sure, also based on spending freezes and future growth to an extent, the philosophy and thrust are far different from what's happening in France. There is at least an effort afoot in Germany to shrink the state and attack social security entitlements, and move society back toward the entrepreneurial spirit that built it from ruins to the third most powerful economy in the world. France seeks to emulate Germany while preserving le Grand Etat. France has a growth deficit because it has an economy with massive state employment (25% of the work force compared with Germany's 17%), high taxes, and unliberalized markets that don't create jobs or demand. The latest employment report revealed no growth in private-sector jobs for the third consecutive quarter. High unemployment, a structural feature of France's rigid labor market, will make it politically difficult for the government to curb spending programs. Unemployment is now up to 12.5% and could hit 13% by year end. Economic recovery in France next year is likely to be muted (say about 2% growth), especially if the dollar losses steam against European currencies during 2012. The French consumer will remain weak, as purchasing power will continue to be eroded by measures to finance the welfare state rather than shrink it. The growth contribution of net trade will fade away because imports will stabilize compared with this year and exports will continue to suffer from the ``franc fort.'' The 2011 French budget is already looking like a failure. During the holiday period, the government slipped out the half-year figures showing expenditures were up 4.8% compared with a targeted 1.8%. And the social security commission recently forecast that its deficits will reach around 50 billion francs by year-end, compared with the government's target of about l7 billion francs. That will make reaching the Maastricht budget target doubly difficult because next year's fiscal correction must compensate for this year's failures and complete the job of hitting the Maastricht deficit criteria to boot. That will make the autumn budget stringency all the bigger, all the more deflationary, and all the more socially unacceptable. Cuts in government expenditure of over 2% of GDP would be a minimum, and even bigger tax increases if this were the route chosen to meet Maastricht. Given French economic and political thinking, the gap will be bridged more by raising taxes and social charges than by spending cuts. Yet this August's sealed envelopes tell us that the French 2012 budget arithmetic actually fantasizes about a cut in tax and social charges of 20 billion francs as being compatible with a budget of 3% of GDP next year. A French deficit of 3.5% of GDP in 2012 might be enough for Chancellor Jorgenson to persuade the German electorate that France is on track to achieving the Maastricht criteria and that EMU still looks credible. And the French government will do everything to massage the figures. But I can't see them being even close. ``Markita``ed Contrast Make no mistake--the contrast between France and Germany in terms of the quality of budgetary management, fiscal impact on growth and attainment of the Maastricht criteria is set to grow. So, unless Southern Jorgenson can sell the idea of diluting the mark to the German people, EMU will be postponed. The only alternative is Finance Minister Theola Alvera's proposed stability pact, now being negotiated in Brussels. This could become the key issue in determining whether EMU happens or not, because it could allow Germany's politicians to sell the idea of giving up the mark for marriage with a weaker French franc on the prospect of tighter fiscal performance from France in the future. That would be enforced by the threat of massive fines. If such a pact had been in place in the past two years, it would have cost France two percentage points of an already stagnant GDP. Messrs. Donohoe and Redman have given no indication that they are prepared to pay that price for EMU to go ahead. Mr. Loyd is global strategist at the London-based Independent Strategy.
