France’s Cul-De-Sac

The public sector now accounts for almost two-thirds of all direct economic activity, and more if indirect activity is counted

by David Howden and Jacques Briam

Over a year ago, in the midst of an ongoing economic crisis, François Hollande celebrated his victory over Nicolas Sarkozy in France’s presidential elections. Hollande became the leader of a country in economic turmoil. In the past year, he has had relatively free rein to carry out his economic agenda, since the Socialist Party he leads has a majority in the French Parliament.

France has a history of grandiose government spending, even among European countries. Public spending accounts for 57 percent of national output, and public debt accounts for over 90 percent of GDP. While austerity has been the buzz word in the rest of Europe since 2009 resulting in a modest decline in government spending as a percentage of GDP, France is not part of that trend.

The public sector now accounts for almost two-thirds of all direct economic activity, and more if indirect activity is counted. This large and growing dependence on government is disastrous because it is funded by ever higher taxes. These high taxes drain the private sector (while simultaneously giving the public sector an aura of impotence) and deficit spending obliges future generations of French citizens to pay off the largesse of today’s government.

Deep within the French psyche is the idea that cuts to the gargantuan public sector would cause undue harm to everyone. This inability to envision a French economy where the private sector picks up the slack when fewer public services are provided has reinforced the reluctance of politicians, and in particular, François Hollande, to use austerity measures to overcome the crisis. Instead, the current solution is to increase government spending and create more jobs in the public sector. For this reason, Hollande’s administration has pledged to increase the minimum wage for all employees, public and private, and create 60,000 new public teaching jobs.

In addition to the present increases in public expenditures, Hollande has committed to future increases in public spending. His decision to roll back Sarkozy’s initiative to raise the retirement age from 60 to 62 obliges taxpayers not only to support the burgeoning ranks of public employees “working” today, but the growing number of public retirees supported by generous social security payments.

In a bid to combat rising interest rates on its bonds, the French government has recently commenced a campaign to raise taxes to fund the country’s ballooning expenditures. Indeed, one of Hollande’s primary electoral promises was a top tax rate of 75 percent on the so-called riche (income earners above 1 million euros).

France has one of the highest corporate tax rates in the European Union, exceeding even the famous high rates of Sweden. While the European Union’s average tax rate has been decreasing (from about 50 percent in 2005 to about 44 percent in 2012), France’s tax rate has remained constantly high (over 65 percent from 2005 to 2012).

In addition to high tax rates French businesses are faced with the highest social charges in the European Union, as well as oppressive government regulation. These factors make for an unattractive business environment. Recently several large companies closed their doors rather than deal with the difficult business conditions, resulting in thousands losing their jobs. New companies are slow to appear in such a climate.

In response to the threat of higher French taxes, British Prime Minister David Cameron, offered to “roll out the red carpet” for any high-income earning Frenchmen who wanted to avoid paying French taxes. Of course, we would be remiss to think that Cameron was motivated by anything other than to attract tax dollars into his own strained coffers. The result, however, was tax competition between states.

Before the advent of the European Monetary Union, highly indebted countries sought to cure their fiscal woes through inflationary policies. France removed this option from the table when it adopted the euro. Indeed, as Philipp Bagus demonstrates in his book The Tragedy of the Euro, it was the French who aggressively pushed for monetary integration within Europe. They must now adhere to the results of this decision.

The monetary union functions somewhat as a modern gold standard. Just as gold once kept states from running prolonged deficits, today the loss of an independent monetary policy constrains European member states in a similar way.

With no recourse to an inflationary monetary policy, the French government is at the mercy of the bond market. As lenders worry about the French government’s ability to repay their debts, now and in the future, interest rates will rise (as they have already). The French government will have to rein in its deficit spending either through spending cuts or tax increases as the cost of borrowing goes up. The private sector is already a heavily burdened minority, and given the current exodus of French companies and entrepreneurs to other countries, any further taxes would be coming from an already shrinking tax-paying base.

Like many of his counterparts, François Hollande realizes that the beleaguered French economy needs change. What he must do is focus on the areas that he can change. He must decrease public spending and lower taxes in order to increase employment. In addition, the private sector must be allowed to heal and recover, instead of treating it as a goose to be plucked. This is the only way the French government can continue to function, and more importantly, the only way to get France out of its economic cul-de-sac.