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France’s Imminent Competitiveness Shock

By The Editors
November 12, 2012 6:29 PM EST

The government of French President Francois Hollande deserves credit for its decision last week to cut payroll taxes.

Unfortunately, by itself, the 20 billion euro ($25 billion) reduction in costs for companies won’t administer the “competitiveness shock” that a dire, government-commissioned study recommended Nov. 5 to revive growth.

It certainly won’t allay the concerns of France’s largest trading partner, Germany, whose own economy would be at risk from a meltdown across the Rhine. As Germany’s Council of Economic Experts delivered its annual report to Chancellor Angela Merkel last week, one of its members, Lars Feld, warned that “the largest problem isn’t Greece anymore, or Spain or Italy, but France because France has done nothing to rebuild its competitiveness and is even heading in the opposite direction.” A recent cover line on the daily Bild Zeitung baldly asked: “Will France Be the New Greece?”

The French government’s response fails to tackle the more fundamental challenge of curbing out-of-control public spending and easing France’s rigid labor laws, which were identified as the gravest threats to the economy both in the report by former Airbus SAS Chairman Louis Gallois and in a review published the next day by the International Monetary Fund.

German Model

Both point to the steady deterioration of France’s trade balance and industrial jobs over the past 10 years, particularly compared with Germany.

Examples abound: France’s hourly labor costs average $44, 13 percent higher than those in Germany, which has restructured its labor market to give employers more flexibility in hiring and firing. France’s labor costs, meanwhile, are up about 19 percent over the decade, even as Germany’s have held almost constant. France’s share of euro-area exports has dropped by 3.5 percent, more than any country in the region. To wit: Germany posted a trade surplus of 150 billion euros last year, while France had a deficit of 70 billion euros. Most dramatically, France’s unemployment rate is hovering around 10 percent; Germany’s is 5.5 percent.

Meanwhile, French companies have seen their operating margins shrink almost 40 percent in the last decade; those of German companies have gained about 40 percent.

The government’s decision to cut payroll taxes next year by 20 billion euros is one of the 22 recommendations in the Gallois report. But the French employers’ federation, Medef, estimates payroll costs on French businesses would have to drop by 70 billion euros, more than three times as much, to be competitive with Germany.

More broadly, the government’s proposal falls far short of the “serious structural reform” the IMF said that France needs, and that Spain and Italy have already painfully initiated.

If France is serious about reforms, its next step should be to repeal the 35-hour workweek, a 12-year-old experiment that has created a costly administrative nightmare, and has failed to alleviate unemployment. The government also needs to make it less onerous for companies to hire -- and especially fire -- employees by changing what Gallois aptly called a “cult of regulation.” As things now stand, labor laws aimed at blocking dismissals also prevent companies from managing their workforce, including by hiring part-time workers.

To reverse what Gallois described as the accelerating “unhooking” of the French economy over the past decade, France will have to scrutinize its cherished -- and impossibly costly - - social welfare state. Public spending that accounts for 56 percent of gross domestic product can’t be sustained, a point that both Gallois and the IMF highlight. By contrast, such spending amounts to 46 percent of Germany’s GDP.

Deficit Reduction

Hollande has promised to narrow the budget deficit to 3 percent of GDP next year, from about 4.5 percent this year. He has already announced tax increases -- including an absurd 75 percent rate on the highest incomes and higher sales taxes -- and probably doesn’t have any room on the revenue side.

He will have no choice but to look at cutting expenditures. In addition to his freeze on public spending, he now needs to ask French labor unions, public-sector workers and the middle class for greater sacrifices, including reduced benefits and delayed retirement.

Hollande would need to show uncommon political courage, with no promise of success. The deterioration of competitiveness has occurred over 10 years, a period when France had governments from both the left and right -- proof of the country’s entrenched resistance to reform.

He might not have much time to act. The Bank of France indicated Nov. 9 that, after three quarters of stagnant growth, France might be tipping into recession as the economy contracts. The European Commission predicts the French economy will grow a feeble 0.4 percent in 2013, half the pace expected by Hollande’s government, after 0.2 percent growth this year.

France shouldn’t be lulled into a false sense of complacency by the markets, where it can still borrow at bargain-basement rates of about 2 percent. As we know from the experience of Greece, this relative calm can end overnight. Hollande has a chance at his news conference today to lay out the harsh truths facing France’s economy. Let’s hope he takes it.

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