Moody’s announcement in November that it had
downgraded France’s sovereign-credit rating by one notch from its AAA rating
prompted one blogger to poke fun at rating agencies’ tendency either to get
things completely wrong or to recognize suddenly a crisis that had long been
staring them in the face. The blogger joked, “If this recognition by a rating
agency that France has problems is an example of the first failing, a recovery
must have begun; if it is an example of the second failing, the country faces a
dire reckoning.”
French President François Hollande’s government claims
to have awoken to the threat. In a recent interview, Finance Minister Pierre
Moscovici likened the measures being undertaken to reduce the country’s debt
burden and restore competitiveness to a “Copernican revolution...because these
choices were not clear for a French government or for a center-left
government.”
As proof of this new realism, the government has been
trumpeting its response to the set of policy recommendations that an expert
panel led by the business executive Louis Gallois presented two weeks before
the downgrade. The response is centered on a payroll-tax cut, which will be
offset by spending cuts and a higher value-added tax.
In the run-up to the downgrade, an analyst at Moody’s
said that the decision would be based largely on whether the government heeded
the Gallois report’s call for a “competitiveness shock” to France’s economy.
The downgrade thus suggests that Moody’s considered the government’s response
insufficient.
In fact, this negative verdict barely scratches the
surface of France’s predicament. The full picture emerges only after examining
the motivations behind the government’s inadequate response.
The underlying explanation lies in the culture and
prejudices of France’s governing elite, the so-called grands commis formed
by the National Civil Service School of which Hollande – like virtually all of
his predecessors, except Nicolas Sarkozy – is an alumnus. In this cloistered
world, a prosperous and just society requires a state-directed economy.
This dedication to dirigisme has spawned among the
ruling elite a sense of entitlement and hostility to business. Indeed, for
France’s political leaders, business amounts to a zero-sum competition to
capture a higher share of total value added for owners and managers, at the
expense of labor.
Criticism of this anti-business approach is usually
dismissed in France as “ultra-liberal” flailing against the “social model” that
the French nation has embraced. But the example set by Scandinavian countries,
which combine a generous welfare state with pro-business policies and
traditions, repudiates such claims.
The main difference between the failing French model
and the more successful Scandinavian approach lies not in welfare “outputs”
(many public services in France, such as the health-care system, remain among
the best in the world), but in how they are financed. The Scandinavian social
compact rests on the understanding that citizens must pay high taxes in
exchange for public services.
While French public spending – which stood at 56% of
GDP in 2011 – is
at or above Scandinavian levels, French households pay lower tax rates on
consumption and personal income. The gap is bridged by a mixture of deficit
spending and high taxation on employment.
Relentless government borrowing and high payroll taxes
(employer-paid social security) have long sustained citizens’ illusion that
they are getting something for nothing, while perpetuating successive
governments’ misconception that taxing business is a painless way of financing
welfare and public services. But it is increasingly apparent that this approach
has undermined public finances and competitiveness – and that households end up
picking up the tab. (In fact, chronically high unemployment has meant that they
have been doing so for years.) Now, citizens are facing higher taxes and cuts
to public services.
Defenders of the French system quibble over labor-cost
statistics in their efforts to prove that France is not so different from its
main European trading partners. But the facts of the last decade – including a
significant loss of export-market share and a 5%-of-GDP deterioration in the
current-account balance – paint a different picture.
Moreover, this line of defense misses the point. The
burden of payroll taxes, together with overweening labor-market regulation,
stifles entrepreneurship. If Hollande’s tax hikes – on income (including a
temporary 75% tax rate for the country’s wealthiest households), dividends,
capital gains, and capital assets – are not enough to deter entrepreneurs, the
cost of hiring workers and the difficulty of firing them remain powerful
disincentives.
Far from signifying a pro-business shift, Hollande’s
government’s response to the Gallois report reflects the French elite’s
enduring interventionist mentality. Instead of implementing deep and permanent
cuts in payroll taxes on businesses, the government will give companies a €20
billion ($26 billion) income-tax credit over the next two years. And, with
companies required to apply the rebated cash to investment and job creation,
the government has portrayed the measure as a cut in taxes on labor that will
boost employment. But a temporary tax break cannot change incentives.
Furthermore, companies will not receive the cash until
2014-2015, owing to the complexity of France’s tax administration. And, when
they do get it, the state cannot possibly know that reinvesting in the same
enterprise will be more beneficial than, say, paying out dividends that
shareholders could then use to finance a new venture.
Once again, French lawmakers are acting on the
conviction that they know better than market participants. Apart from promises
to reduce employment regulation, all of the new measures boil down to officials
directing state money and subsidies to companies and projects of their
choosing.
So the death rattle of the French economic model
continues. What remains to be seen is how the end will come. And, whether it
comes in the form of a capital strike by foreign bondholders, or of domestic
labor strikes and wider social and political unrest, France’s leaders remain
entirely unprepared for the inevitable.
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