1 Oct 2014

One man could save La France, but is he up to it?

Alexia T writes:*

Whilst the French economy has not down-spiraled like that of Italy, Portugal, Spain, or Greece did a couple of years ago, many fear that if another European economy is to wash down the drain, it will be that of France.

The French economy has for a long time been considered as one of the leading economies in Europe. France is amongst the leading industrial economies in railway, automotive, and aerospace sectors, as well as in pharmaceuticals, telecoms, defense, and luxury goods. Nevertheless, in recent decades, the development of state aid in certain economic sectors, and the cost of infrastructure programs and social services, has led to a huge increase in the French state’s budget. And even though the extent of the French state’s involvement in the economy has proven to be one of its greatest strengths, it has also been one of its main weaknesses.

To finance most of its programs, the French government, like most governments, has resorted to increase taxation, however, most of that has fallen on businesses: French businesses currently have one of the world’s highest level of payroll tax ranging from 43% to 60%. Excessive corporate taxes are damaging the French industry, especially as it discourages corporations – French or foreign – to invest in France, and it is seen as one of the main causes for France’s widespread unemployment.

To a large extent, due to traditional (and ironic) public opposition to reforms over the past three decades, the misfortune of the French economy can be traced to the inability of its political leaders, on both right and left, to push through the necessary actions in troubled times.

Unemployed in millions (left axis) and in percent (right axis)
Since President Francois Hollande came into power in 2012, unemployment rates are at its highest ever since the late 1990’s, at a staggering 10.2%. Two years into his presidency, all that voters who had hoped for big changes can observe is the worsening of unemployment (see figure), a rise in taxes, and a gradual decline in living standards. Hollande promised to stimulate growth of the economy and reduce unemployment, however next to none of this has been materialized due to the inflexibility of rules and policies in place.

Reasons for the high unemployment rate differ, but one of the most important reasons is prohibitively high labor costs. France's high minimum wage makes it expensive and thus difficult for companies to recruit entry-level staff. Then there are very high social charges (payroll taxes) and strict labor laws that make it difficult to let go of people -- and therefore difficult to hire – even during economic upswings. With these laws, many enterprises have either moved to countries with lower production costs, become smaller in size, replaced human labor by technology, or simply had to pass on growth opportunities. With the higher cost, margin of profit goes down, decreasing their ability to be innovative and to develop. France needs at least 1% economic growth to create jobs, and 1.5% to stabilise unemployment, but since the economy’s growth will not surpass the 1% this year, a reduction in unemployment is practically impossible.

To lower unemployment, and secure a future for the coming generations, the French economy needs to grow. It needs to start favouring entrepreneurs, the creation of new industries, and make more jobs available for newcomers. The old formula of targeted state aid won’t work this time, mainly because there is no financial backing, so instead it needs to change its laws and policies, and it needs to become more modernised. Hollande should focus on reviving the French economy, and to succeed he needs to do what no other French president has mastered – to confront the multitude of interest groups that, through strikes and protests, have a tradition to stop any and all reforms.

Bottom Line: If you're going to make an omelet, then you have to break some eggs.

* Please comment on these posts from my microeconomics students, to help them with unclear analysis, other perspectives, data sources, etc.

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