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The next presidential election in France is scheduled for April 2017. In the coming weeks President Hollande is expected to announce his decision to run for a new mandate. Or not. The polls have consistently shown Mr. Hollande has no chance to win. In addition, the president might lose the Socialist primaries to his former minister and present-day critic Arnaud Montebourg. Mr. Hollande's popularity hit a record low as the public blames him for the economic hardship France has endured over the last four years.
Is the vox populi right?
The key promise of the candidate Hollande was to reverse the rise in unemployment by the end of the election year. It took three years for the first signs of that promise coming true to appear, yet the number of unemployed in April 2017 may still end up higher than five years before. Years of rising unemployment were also years of stagnant GDP growth.
From 2012 to 2016 real GDP grew by 4% in France, a poor performance compared to other large EU economies (+5.6% in Germany, +5.8% in Spain, +9.0% in the UK, only Italy did worse) or with the period 2008-2012 (when France outperformed most of the EU). Why did France fare so badly under Mr. Hollande?
In 2012 the new host of the Elysée Palace faced two major issues. On one hand, the fiscal solvency had seriously deteriorated since 2007 following the crisis and the expansionary fiscal policy response. From 2.5% in 2007 the fiscal deficit increased to 5.1% in 2012, while the public debt to GDP ratio increased by 20.8 percentage points, and stood at 85.2%. On the other hand, the external competitiveness of French companies had been deteriorating for a decade: in 2002-2012 their international market shares declined by 25%. Trade balance, in deficit since 2004, sank to -15% by 2011 and the current account deficit grew over the same period. The French industrial decline and the ensuing external deficit had deeper implications. France had specialized in unsophisticated goods and services, competing through prices rather than quality.
Thus, in 2002-2008, as the euro rose against the dollar, the trade deficit widened. Lost market shares led to falling profit margins, which aggravated the problem as firms had less means for investing and moving up market. While France had no problems financing its external and fiscal deficits, the loss of competitiveness and the unsustainable fiscal path raised a threat of a "sudden stop". Since 2009 the dominos were falling one by one - Greece, Portugal, Spain...
Was France to be next? The early warning signs appeared in January 2012 when the country lost its' triple A. An unanticipated massive loss of confidence from the economic agents, leading to skyrocketing interest rates on sovereign debt, had always been an ulterior motive behind Mr. Hollande policies. The new president had to square the circle: restore fiscal sustainability while making the industry competitive again. Increasing industrial profit margins through tax cuts would further deteriorate public finances. Fiscal austerity, in turn, would further squeeze profit margins. Faced with this dilemma, Mr. Hollande proved himself fatally unable to choose.
The inconsistency of his action is striking when you consider the issue of corporate taxation. In 2012-13 the priority was given to fiscal consolidation. Reining in the fiscal deficit led to an unprecedented tax shock: plus €36.8 billion over the first two years, of which €14 billion was in corporate taxation. In the context of a slowly recovering economy, the tax shock destroyed business confidence and the incentives to invest. Its effects were further aggravated as other euro zone countries also turned to austerity. In 2014 the previous policy was reversed, the goal now being to restore firms’ competitiveness. A variety of fiscal measures provided corporate tax breaks which offset previous corporate tax hikes by €20 billion The reduction in payroll taxation was paid for by higher consumption taxes. The idea was to bring down unit labor costs for home producers, while the sales of domestic and foreign goods would be taxed alike. Overall it would make home producers more competitive.
The increase in profit margins would allow investment, moving up market and ultimately hiring. The first modest effects of this policy came to fruition in the end of 2015.
So what is the overall impact of the Hollande policies in comparison with other major economic changes? The French economic institute OFCE did the math. The fiscal policy – the sum of tax hikes and tax breaks – cost the French economy 0.8 pp. of GDP annually from 2012 to 2017. By contrast cheaper oil and the euro depreciation increased the GDP by an equivalent of 0.2 pp annually each. The slowdown of emerging countries and the crisis in the construction sector cost respectively 0.3 pp and 0.2 pp. per year.
The fiscal shock of 2012-13 undermined growth perspectives for the years to come. The purchasing power of the French at the beginning of 2016 was lower than in 2011, due in particular to the ever-higher tax burden on households: +€35 billion in 2012-2016. Yet, even though this fiscal consolidation was among the toughest in the EU, it failed to put public finances on a sustainable path. The public debt to GDP ratio grew by 6.6 pp from 2012 and 2016. The failure to bring the fiscal deficit to debt-stabilizing levels keeps French public finances dependent on the ECB expansionary monetary policy. If interest rates were to rise, the fiscal sustainability issue would be back to the top of the agenda.
It's true, Mr. Hollande's policy brought industrial profit margins back to their 2002 levels. Yet fiscal devaluation was in part compensating for the damage inflicted by the tax shock in 2012-2013. Had this strategy been enacted as early as 2012, the effects would have probably come earlier. Another concern is how long its effects will last. In the medium run lower payroll taxes will ultimately translate into higher wages, erasing the initial competitiveness benefit. A more fundamental criticism is that labor cost reduction is a beggar-thy-neighbor policy, leading the EU countries into a downward spiral of wage restraint with, as a result, a depressed demand everywhere across the EU.
What about structural reforms? Here as well the added value of Mr. Hollande’s mandate is rather limited. The administrative "simplification shock” implied only cosmetic changes. The El Khomri law (labor regulations) and the Macron law (liberalization of the markets of goods and services) were a great to-do with precious little to show for it, largely gutted by Mr. Hollande’s own party.
Over his long career François Hollande has been praised for the ability to strike compromises. Unfortunately the strength of the politician turned into a major weakness of the statesman. Mr. Hollande proved consistent in his failure to choose: between supply side politics and fiscal consolidation, between "Brussels" and his own party, between public opinion and common sense. Largely due to this, Mr. Hollande is now left only with the choice on what his political demise will look like..