Is France the New Italy?

With or without new monetary stimulus, though, France needs reform

By Bloomberg

If U.S. President Barack Obama thinks he’s having a difficult autumn, then maybe he should consider the season French President Francois Hollande is experiencing. Paris in springtime may have been lovely as usual, but fall has been horrible.

The French unemployment rate stands at 11 percent. After growing tepidly in the second quarter, the economy shrank again in the third. Standard and Poor’s just downgraded the government’s debt -- for the second time in less than two years. Hollande’s Socialist administration faces protests over taxes and burdensome regulation not just from business leaders, as you might expect, but also from farmers, shopkeepers, teachers, truck drivers and soccer players.

The European Commission recently called on the government to speed up economic reform. Speaking from its conveniently located Paris headquarters, the Organization for Economic Cooperation and Development restated the message in a detailed report issued last week: “In recent years, a significant adjustment has been under way in several European countries that have accelerated the introduction of essential reforms. This adjustment hasn’t yet happened in France.”

The White House is concerned that some recent polls have shown Obama’s approval rating dropping below 40 percent. For Hollande, who was elected only last year, it stands at 15 percent.

Even discounting for the French flair for umbrage, the backlash against Hollande is extraordinary. The economy -- the second-biggest in the euro area after Germany -- is in deep trouble, and the government looks helpless. Seemingly intractable problems and a lack of effective leadership threaten to turn France into Europe’s new Italy.

Hollande was unlucky to come to power while the wider European Union economy was still on its knees, and he inherited an array of bad policies from his predecessors. French industrial competitiveness fell sharply in the years before he took office. But his initiatives have mostly made matters worse. In an effort to be populist, he introduced a temporary 75 percent tax on earnings of more than 1 million euros ($1.3 million) -- a measure that's largely self-defeating from a revenue-raising point of view. He then undid any political benefit with an array of smaller tax increases, leaving much of the country feeling as preyed upon as the rich.

Leaning heavily on higher taxes, the government has been slow to get public spending under control. France’s ratio of public spending to gross domestic product is now 57 percent -- the highest in the euro area.

Heavy-handed regulation is another drag on the economy, and it’s a main focus of the OECD’s complaints: Product regulation in France is stricter than in most other European countries, and labor-market rules raise costs to well above the EU average. Taxes account for an estimated 50 percent of labor costs.

Hollande has made some feeble efforts to improve competitiveness -- notably, a package of tax relief for businesses. The OECD reckons it will reduce the tax disadvantage French employers face but won’t eliminate it. Other opportunities for reform, including a review of pension rules, have been allowed to slip by.

Germany could help France -- and the rest of Europe -- by backing a more expansionary monetary policy for the euro area. With or without new monetary stimulus, though, France needs reform. To spur growth, the government has to curb its spending, moderate its tax demands and start liberalizing the economy.

That’s a difficult prescription to apply while unemployment is high and the economy is shrinking, and not one that comes easily to a Socialist administration under simultaneous attack from both the left and the right. It requires a strong leader, too. In foreign policy – on Syria, for instance, and on Iran -- Hollande has been willing to assert himself. In domestic policy, he hasn’t.

He had better rise to the challenge, because the alternative is grim. Financial markets haven’t yet focused on France’s difficulties -- Europe has many other economies whose problems are harder to ignore -- but that could change quickly. If it does, the problems will multiply.