France: a nation on the edge

With three million unemployed and prospects of anemic economic growth, the strategy for deficit reduction adopted by the government of President François Hollande risks pushing France to the edge of a cliff. So argues economist Eric Heyer, who writes on economic theory for l’Observatoire français. Business without Borders’ sister publication, Affaires sans frontières ecently spoke with Heyer in Paris.

President François Hollande has placed deficit reduction at the top of his agenda, reducing it to no more than 3% of GDP by 2014. He gives himself two years to redress France’s deficit. Is this a good strategy?

I’m not in favour of the strategy as he’s practising it today. Returning to a balanced budget quickly isn’t desirable in our current economic state. And to work it requires the participation of all European countries.

The only success stories in the history of the fight against deficits were in countries that were alone in their problem. There was economic growth elsewhere. We are the opposite of all that—all the countries of the euro zone are conducting the same austerity policy at the same time. We cannot devalue our currency, and monetary policy does not work. Under these conditions, it is impossible to arrive at a balanced budget without having a significant cost on growth, job creation, unemployment and poverty. By only putting a priority on the public deficit, we risk widening the gap further. I find it curious that in a great, rich democracy like France that concentrating on the public deficit should create poverty. In fact, it is rather amazing.

The president announced that he would however also reverse the pattern of employment in the same period. Is this feasible?

I do not believe at all. For François Hollande, economic recovery means a return to fiscal balance first and then take care of the job growth. It’s a smart strategy from a political point of view, but from an economic point of view, it’s is a disaster. These deficit reduction measures are not only unpopular, but counter-productive, and it will be difficult to reverse the trend.

A common misconception is that even if unemployment rises, one has only to restore growth and then drop it. But after four years it increases, the unemployed are discouraged. Their situation has deteriorated. A study revealed that for every 100 unemployed workers in 2010, 45 gave fell below the poverty line in 2012. Long-term unemployment will explode and that is what is worrying.

In France, we have had 1.7 million unemployed in the past year and 900,000 unemployed for more than two years. And the longer you stay unemployed, the more difficult it is to return to employment. With the explosion of unemployment we saw in 2012, imagine what will happen if we are still in recession in two years’ time. Especially as we know that when growth returns, it takes three quarters before being translated into job creation, which leads us to 2015—in the best case. Those who have been out of work will have been unemployed for six. That represents 1.5 to 2 million people who will not find employment. This is unheard of.

What should he do then?

We must go slowly in the fight against deficit reduction and find a rhythm that allows at the same time fight against unemployment, which does not affect growth, consumption, investment and trade, which are engines of the economy. The idea is not to turn off all motors simultaneously.

I’m not saying that deficit reduction is not important, but you will not find many economists to tell you that it will not cause a recession. In Europe, we have chosen this strategy to deleverage publicly first. In the United States, as households deleveraged and businesses have paid off debts as well, the government has held off on attacking its public debt. Result: we see economic growth in the United States. It is small, yet with a public deficit of 9.5%. In Europe, we are reducing deficits during a recession.

Is raising taxes the best solution for the short term?

Research tells us that it’s better to raise taxes than cut spending to reduce the deficit without slowing growth. Because when you lower costs, it penalizes especially the masses. A progressive tax is preferable.

If you donate $100 to a person of the lower classes, they will spend $99 and savings will be almost zero, while if you give the same amount to a more affluent person they will save $30 and spend $70.  As you tap different classes, you turn on consumption automatically. At present, companies tend not to invest because the demand is not there, then it seems more just not to touch public spending to encourage consumption rather than saving.

But with too heavy a taxation burden—as much as 75% of wages for the wealthy—isn’t Hollande risking driving the rich out of France?

On the other hand, we realize that lowering taxes won’t induce those who have left to come back. Suddenly, you’re trapped. And in the context where you want to quickly return to 3% deficit, I do not see how you could not make the rich pay. We are obliged to ensure that the effort is shared between everyone and it is normal that the burden should rest more on the rich than on the middle class and the poor. It can only be achieved by raising taxes. The 75% rate on wages million and will affect approximately 1,000 people. It is a symbol to show that an effort will require everyone, including the richest.

But beyond its debt problems, does France have problems of productivity and competitiveness?

We actually have two problems. First, we have not made ​​the effort to go upmarket in some areas. We stayed in the low cost arena. And there is the fact that we have not tried to diversify. We stayed very close to European countries without trying to open other markets, whether in emerging or growing markets.

We focused on the medium and low-end and in countries where growth is weak. Germany chose to lower wages to be more competitive. It won against neighbouring countries but not against China, India or other low-wage countries. I think we should rather go to the top of the range and innovation. It takes more time and investment, but it is more profitable in the long term. If we all become like the Germans, we will not win competitiveness.