Wednesday, November 26, 2014

François Hollande’s Wrong Idea of France

LONDON – France’s new president, François Hollande, has achieved a remarkable series of political victories – at home and in Europe – since his election in May. Unfortunately, his streak of success will inevitably call forth an economic reckoning that will shock France’s apparently unsuspecting citizens and doom the French elite’s approach to the “construction of Europe.”

Since winning the presidency, Hollande has won a parliamentary majority and pushed Germany toward accepting joint liability for eurozone countries’ debts. But forebodings of crisis have become widespread in French business and economic circles.

But the real danger – which even Hollande’s sternest critics may be underestimating – is not so much his individual policy failings (serious though they may be) as his approach to the twin challenges posed by France’s economic imbalances and the eurozone crisis. On each front separately, he might manage to muddle through; together, they look likely to cement France’s loss of competitiveness.

Declining competitiveness is best captured in a single indicator: unit labor costs, which measure the average cost of labor per unit of output. In a monetary union, discrepancies in wage growth relative to productivity gains – that is, unit labor costs – will result in a chronic accumulation of trade surpluses or deficits.

Since the euro’s introduction, unit labor costs have risen dramatically faster in France than they have in Germany. According to Eurostat data published in April 2011, the hourly labor cost in France was €34.2, compared to €30.1 in Germany – and nearly 20% higher than the eurozone average of €27.6. France’s current-account deficit has risen to more than 2% of GDP, even as its economic growth has ground to a halt.

The high cost of employing workers in France is due not so much to wages and benefits as it is to payroll taxes levied on employers. The entire French political class has long delighted in taxing labor to finance the country’s generous welfare provisions, thus avoiding excessively high taxation of individuals’ income and consumption – though that is about to come to an end as Hollande intends to slap a 75% tax on incomes above €1 million. This is a version of the fallacy that taxing companies (“capital”) spares ordinary people (“workers”).

Of course, such taxes on firms are always passed on to households – usually through straightforward price hikes, and, in France, also through unemployment. High tax rates on labor – together with rigid regulation of hiring and firing – make employers extremely reluctant to recruit workers. As a result, France has had chronic long-term unemployment – forecast to reach 10.5% by 2013 – for many years.

Hollande’s predecessor, Nicolas Sarkozy, tried to address this problem. He exempted voluntary overtime pay from employment tax and shifted some of the burden of labor taxation onto consumption (via a hike in VAT). But Hollande quickly reversed both of these reforms.

The repeal of the tax break on overtime reflects another economic fallacy to which French Socialist politicians are deeply attached: the “lump of labor” notion that underlay the most disastrous of their economic policies – the 35-hour workweek, introduced in 2000. The idea behind the policy is that demand for labor is a constant, and that this fixed number of aggregate working hours required by employers to meet final demand can be spread more evenly among workers to reduce unemployment.

Such measures, designed to create jobs by freeing up work hours, are futile at best, and are often detrimental. French Socialists should recall their school physics lesson about communicating vessels: when a homogeneous liquid is poured into a set of connected containers, it settles at the same level in all of them, regardless of their shape and volume. Generating more “liquid” (jobs) requires not discouraging the entrepreneurs on whose activities sustainable job creation ultimately depends. The effect of fiscal and regulatory pressure on employment is to encourage French firms to invest and hire outside France.

Hollande’s apologists praise his gradualist and consensual approach to addressing the economy’s structural distortions. They argue that his penchant for setting up consultative commissions is the best way to forge the consensus required for structural reform, whereas Sarkozy’s combative style was counterproductive.

Even banishing skepticism and assuming that Hollande could over time persuade his supporters to embrace competitiveness-boosting policies, the eurozone crisis is denying France the time that such gradualism requires.

A simple, effective way to buy time would be to abandon the euro and restore competitiveness through a devalued national currency. But this expedient is incompatible with mainstream French politicians’ devotion to the “European project,” which amounts to a projection of French soft power; indeed, building Europe lies at the heart of the French establishment’s version of what Charles de Gaulle used to call “a certain idea of France.”

For mainstream French politicians, renouncing the European project to buy the time required to restore competitiveness is as unthinkable as is the logical alternative: an all-out push for full European political union. This would reestablish monetary sovereignty and create a normal central bank (like the Federal Reserve or the Bank of England) at the European level. But it would also mean abandoning France’s republic in favor of a federal European government – anathema to that “certain idea of France.”

The combination of gradualism (on the most generous interpretation) in domestic economic reform and the paralyzing effect of the eurozone crisis will lead to a massive shock. Remaining in a currency union with the much more competitive German economy will require wrenching and rapid reforms, for which Hollande’s tepid approach will fail to prepare the complacent French. The result will be even more support than was seen in last April’s presidential election for extremist political parties that reject both Europe and competitive market capitalism.

Read more from our "Are the French Toast?" Focal Point.

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    1. CommentedClaude Simon

      The choice that french people made is that their social rights are not negotiable. It doesn't fit to mechanical point of view of the author about economy, but the crisis due to competition between social systems is far to be new for France, as it lasts since 25 years. And if you listen prime minster Mr Ayrault, he is inclined to get back 50 billions of interests rates paid every year on public debt to finance new public social services than the contrary.

      Imagine a huge competition to abandon welfare state between all countries, I would say it's a looser run no country will win.
      And all the argumentation of the author is based that french people have to compete with germans. But most of our economies aren't on the same battlefield, so that argument is not so valuable.

    2. CommentedJohn Aho

      Is not the rejection of endless competitive, market capitalism a valid choice? If capitalism (as currently practiced) does not lead to a fair and moral distribution of wealth and work, shouldn't the will of the people be given some attention? Have you noticed, the environment is collapsing and millions are homeless.

    3. Portrait of Christopher T. Mahoney

      CommentedChristopher T. Mahoney

      France has only one hope, and that is to lead a coup at the ECB against the Bundesbank in order to enact inflationary policies that rescue Spain and Italy and provide 5-6% nominal GDP growth. Under the current regime, with 1% nominal growth and 0% real growth, France and the rest of Latin Europe are doomed to depression and political chaos.

    4. CommentedAndrew N Mason

      A key point made to justify the reduction of the workweek, and a very true point, is that efficiency gains are displacing jobs faster than these can be made.

      Technology may in fact reduce the amount of labor required to make goods, even in the emerging economies. This can even be seen in China, where people are being kept employed through the construction of ghost towns and other white elephants.

      Using the 35 hr workweek as a tool to free up time from the people such that consumption and economic activity move towards other activities which are more localized and cannot be replaced by technology may not be a terrible idea after all. Such activities can include art, cuisine, social service and production of goods which have the "human touch" as their main competitive advantage

    5. CommentedJames Bully

      You describe those political parties who would ‘reject’ Europe as extremist, and yet such a rejection is fundamentally what you are suggesting in your call for France to abandon the Euro.

      Is competitive market capitalism even possible – or desirable – when played against an authoritarian Chinese government with an abundance of compliant, cheap labour at its disposal, which has scant regard for the well being and human rights of said labour, and which is gaming its currency, and flouting international trade rules to the disadvantage of its trading partners ?

      The gains from the liberalization of markets over the past 30 years which has lifted China so dramatically out of poverty, in the west has accrued disproportionately to capital. Those gains to the middle/working classes have proven completely ephemeral – asset bubbles manufactured by the growth of credit, and necessitated by the decline in real incomes to maintain the “wealth” required to keep consuming.

      In that sense, this problem you describe is not that of France alone. Indeed, most of the developed western economies will ultimately find their ideas of nationhood, autonomy and entitlement increasingly challenged as it becomes apparent that the pursuit of “competitive market capitalism” is ultimately dependent on those with the least power abandoning hard fought notions of what it means to be free.

    6. CommentedTom Walker

      I live in a "fantasy world" where governments grant exclusive patents to firms, sometimes for products that have been developed with government subsidies. I live in a "fantasy world" where corporations do what they can to limit competition because it's good business to do so. I live in a "fantasy world" where "free trade" doesn't mean the free movement of professionals from country to country. I live in a "fantasy world" where the governments that grant limited liability status to corporations also grant them person-hood (and, of course, bailouts if they are too big to fail). I live in a "fantasy world" where the revolving door spins between Treasury and Goldman Sachs, Defense and Lockheed, the Congress and K Street. I live in a fantasy world where 10% of the total wealth is sequestered by the top 1% of the top 1% in off-shore accounts in tax havens. In short, I live in a "fantasy world" that doesn't obey the "free-market" nostrums of abstract political economy but the realmarket cronyism of an economic system that is well past its "sell by" date.

        CommentedTom Walker

        The preceding post was in reply to Richard Dolan's "I'm not sure what fantasy world you two occupy."

    7. CommentedPaul A. Myers

      Excellent article because it puts the policy emphasis upon structural reform rather than looking to monetary policy to work miracles (the drug of choice among elected politicians almost everywhere!).

      And it is "competitive market capitalism" that is going to capsize the French boat. What I suspect will happen over the next couple of years is that the unit labor cost metric for most of the "advancing" world economies is going to grow increasingly favorable against the entire European Union unit labor cost average.

      Germany may swim against the trend, but many of the other economies will not. France and Italy are two big economies with significant exposure to this trend.

      So getting Germany to do something is one thing, but Brazil, India, China, Africa, and non-Euro Europe are going to really put the heat to the noncompetitive in the coming world economic expansion.

      So that is the big problem with "competitive market capitalism." It competes! And most places, it does not "take direction" well from the finance ministry.

    8. CommentedRichard Dolan

      Those who want to dismiss Professor Granville's argument need to come to grips with the fact that France has persistently high unemployment, and that employers (being rational) can and will expand or relocate in whatever location offers the least-cost opportunity. The gist of Professor Granville's argument is that, for the reasons she cites, France will be on the losing end of that calculus under the Hollande program, and that the eurozone crisis makes it difficult (perhaps impossible) for France to take the steps (principally devaluation) that would otherwise be available to make France a more attractive environment for expanding employment via investment than its competitors in the EU or elsewhere. Talk about 'neo-feudalism' or assertions that 'jobs are not created by entrepreneurs but by consumers rich enough to buy more goods and services' is preposterous. Limitations such as the 35-hour work week count as costs from the employer's perspective, whether or not those limitations are desirable for other reasons. To pretend otherwise is to defy reality. Where the fundamental problem is persistent high unemployment and a comparative lack of productivity and competitiveness, the key issue is whether such limitations are defeating the ability to achieve goals of a higher priority. Of course, from the perspective of someone in France with secure employment, those priorities may look quite different than they do for an un/under-employed recent university graduate. Eventually, of course, the macro-economic problems will come home to roost even for them unless France (and many other similarly situated countries) attends to the fundamental underlying problems.

        CommentedTom Walker

        Reply posted at:

        CommentedRichard Dolan

        Nothing turns on what I or anyone else "wants" for French workers vs. Chinese workers. Quite a bit will turn on what each of those groups earns for itself, if given the opportunity. "Competitiveness and employment" are, first and foremost, economic facts that are routinely measured in objective terms. They can and do change, and are impacted by policy decisions. If the objective is to improve the lot of French workers, in the first instance by ensuring that they have employment to work at, then the policy decisions must be calibrated to achieve that goal.

        Second, consumers provide the 'demand' side of a market, providing the incentive for others to fill the 'supply' side. How the market players on the 'supply' side go about meeting demand is what this discussion is all about. Much of the 'supply' side in the most familiar markets for goods -- clothes, cars, computers, etc., -- as well as services are now performed in locations very distant from those consumers. The result is persistent high unemployment in places like France, where it is becoming ever less economic for producers to locate and invest. One location Professor Granville noted that enjoys higher productivity than France is Germany, but she could easily have mentioned many others.

        Nothing in this discussion is advance by silly prattle about "turning the long-term unemployed into slaves" or "fritter[ing] away in 'work' that we do because we must." No one is about to become a 'slave' (although many are likely to be without a job for the reasons Professor Granville discusses, and will remain that way without a change in direction). And many people (perhaps most) work because they need to earn an income. That is the world Professor Granville and I live in. I'm not sure what fantasy world you two occupy.

        CommentedA. T.

        So you want the average French worker to live like the average Chinese worker so that the average French politician can live like the average Chinese politician?

        Competitiveness and employment are a means to an end, not an end in and of themselves. There can be a policy of automatically turning the long-term unemployed into slaves, for instance, and this would solve the unemployment crisis and improve competitiveness. But to what end?

        Mind you, what, in your reality-denying world, is so "preposterous" about the fact that it is not entrepreneurs who create jobs?

        CommentedTom Walker

        Professor Granville's argument doesn't come to grip with any facts. She kowtows to hollow neoliberal platitudes while people's lives are being frittered away by those facts.

        Cory Doctorow, Mark Fisher and Federico Campagna do come to grips with the fact that, in Doctorow's words, "The system distributes the gains of automation so unevenly that a tragically overworked class is pitted against a tragically unemployed class. Meanwhile, the only resource that is truly non-renewable -- the time of our lives -- is frittered away in 'work' that we do because we must, because of adherence to doctrine about how money should flow."




    9. CommentedTh Hsu

      Great article. Living in Alsace, between France, Germany and Switzerland one can observe the change in competitive landscape between these countries. Nowadays, even French people try to find work in Switzerland and do a significant part of their shopping in low cost Germany. There is no much reason to earn or spend money in France. However, France's problem is not Switzerland nor Germany. It's China, India, Taiwan, Singapore, Brazil, etc. The inability to become competitive in these markets will be detrimental to the French economy on the long term and ,like you, I am struggling to see Hollande's positive contribution here.

    10. Commentedpeter jay

      brilliant article. of course, de gaulle'sidea of france could be combined with the french elite's approach to the construction of europe if germany became part of france, which then equals "Europe". that was the vision i first heard from Jean Monet in 1952. Is that really what Frenchmen should wish for ? Better scrap the Euro, devalue early, devalue often and enjoy export-led growth.

    11. CommentedA. T.

      First, it seems to me the problem is with wealth being over-centralised (to a degree that can only be achieved through many, many, many generations of inheritance) rather than free, fair, unfettered, and everyone-starting-from-the-same-place competition, rather than with a lack of labour competitiveness. If capital will move to the place where it can exploit labour most (forget German labour costs, look to Taiwan and China), and few people have capital, the only way to keep capital at home is to introduce neo-Feudalism. Yes, capital will stay in Europe if most Europeans are made to live as serfs while a small elite lives in opulence. But what would be the advantage of that?

      Second, entrepreneurship is not primarily stifled by fiscal and regulatory pressure, but by insufficient access to seed capital, excessive risk associated with the failure of a venture, and predatory practices by already-established large competitors.

      Third, jobs are not created by entrepreneurs but by consumers rich enough to buy more goods and services. We know what we want, and we know how to make it. The stumbling block is that most people cannot afford to buy what they want. An entrepreneur will create no jobs if no one can afford to buy what he or she has invented. An entrepreneur will create no net jobs if the purchase of his or her product comes at the expense of the ability to purchase something else.

      Hollande's policies are rather misguided, but they are notably less misguided than those of the French right.

    12. CommentedMark Pitts

      A good reality-based article. But since most prefer to dream rather than think, you will be severely criticized.

        CommentedMark Pitts

        You're wrong. The people who changed all that were dreamers and thinkers.

        CommentedA. T.

        If no one ever dreamt, we would still be living in absolute monarchies and feudal economies.

    13. CommentedTom Walker

      Third-rate propaganda boilerplate from a "Professor of International Economics and Economic Policy"? Have you no shame Professor Granville? As Frank O'Callaghan observes, this column is "stunning in its acceptance of failed conventional wisdom."

      It is also professional malpractice in its ill-informed embrace of the bogus charge that the 35-hour work week was based on a "lump-of-labor fallacy" and its insinuation that the policy was futile or even detrimental. There were disputes over the degree of success achieved by the policy -- as with any controversial measure -- but the verdict of "fallacy" and "futile" has no basis in the empirical research on policy outcomes. Those claims are based solely on the propaganda of sworn antagonists of the shorter work time measure.

    14. CommentedFrank O'Callaghan

      This is stunning in its acceptance of the failed conventional wisdom. The idea that "jobs" can be provided for a whole workforce with the current production and distribution modes is absurd.

      A distribution of work, resources, free time (or unemployment/leisure) and power is the only solution to the current crisis. The classical economic theory is a failed experiment. An orderly withdrawal from it's strictures is necessary and overdue.