by David Roche
It was before the wave of strikes that hit France in December that I glided into the Gare du Nord on one of France's ultra-smooth, ultra-expensive (to the taxpayer, not the traveller) TGVs. I had two questions begging answers. First, would the Franco-German axis in Europe hold? And second, would France meet the Maastricht criteria for a European single currency by the end of 1997?
As I sat in the TGV, I let my imagination run ahead to summer 1997. France is still short of closing its budget deficit at Maastricht levels. There is disorder in Paris and other major cities because unemployment is between 13% and 15%. President Chirac announces his fifth (predominantly tax-raising) emergency budget. He feels increasingly like a dog chasing its own tail and looks increasingly like one with its tail between its legs. The more he raises taxes, the weaker the economy gets and the more radical support grows for maintaining France's expensive social safety net. So the bigger the deficit grows.
Over in Germany, chancellor Kohl is approaching retirement. His last general election will be in 1998 and he wants to go down in history as the man who united Germany and then made it safe by uniting Europe too. So he and president Chirac agree to abolish the exchange markets for their respective currencies and peg the French franc to the Deutschmark at an irrevocable fixed-exchange rate to preserve the Franco-German axis.
Would that work? The answer is probably no. There are many reasons why a Franco-German monetary union wouldn't wash. The concept of the state is a good starting point. While Belgians expect nothing but austerity from their government, the French still expect everything. That's why Chirac won office - by promising higher wages and more jobs.
Beneath this view of government lies a very different concept of capitalism in Belgium and France. In this, as in foreign and defence policy, France has sought to walk alone. Belgium, having no such nationalist pretensions, can bear the relatively smaller cost of harmonizing its economy with Germany's. To do the same, France would have to take much harder political decisions which, so far, it has failed to do.
They are harder because France has sought to create an independent economic model of capitalism. It represents a strange mixture of shareholder and state capitalism, with incestuous links to the state bureaucracy and the grandes écoles. This model has failed in key areas like software (Cap Gemini), computer technology (Machine Bull), defence (Dassault, Aérospatiale), finance (Crédit Lyonnais), telephony (Alcatel), water (Lyonnaise des Eaux and Générale des Eaux) and transport (Air France and SNCF).
Failure has occurred for several reasons. First, nationalism is the enemy of global competitiveness when it comes to market size. Second, bureaucrats generally make poor managers of free-market enterprises. And third, cosy relations between the bureaucracy and the private sector help shield French corporates from competitive pricing and hinder the efficient use of labour. These failures of state capitalism dwarf the relative successes of the French free-enterprise sector such as Carrefour, L'Oréal and Club Med.
The French model has increased the sum of state indebtedness. The accumulated losses and subsidies of many companies like SNCF and Air France rival the announced deficits and debts of the social security system. The SNCF rail company makes an annual loss of Ffr12 billion, it gets subsidies of Ffr55 billion and has debts (now Ffr175 billion) too. After the recent wave of strikes, prime minister Alain Juppé agreed to take up to one-fifth of that debt off its books and cancelled the proposed restructuring of the company. Similarly, Air France is about to get another Ffr20 billion from the state. And then there's Crédit Lyonnais with its Ffr130 billion of bad loans being taken off its books by the government. Beside these huge commitments, the social security deficit of Ffr64 billion that Juppé aims to eliminate is just high-profile peanuts. Le mal français est plus grand et plus profond!
Unwinding all these hidden deficits means unwinding a way of life and changing political philosophy to boot. Worse, it means big increases in short-term unemployment. I think that France is still too wedded to the philosophy of mind over market to make that change rapidly enough to meet the Maastricht criteria. To be fair, the highly intelligent and skilled senior bureaucrats I met in France swore that this change was under way. You must choose who to believe.
Schizophrenic about Europe
So France could never go for a dual-currency regime with Germany. Unlike a single European currency, it would entail abandoning the franc as the solenational currency by giving the Deutschmark equivalent status. That dilution of sovereignty would be political suicide for those who decreed it.
The Belgians would do it. There, ethnicity is common and nationalism rare. Belgian support for Europe is unanimous among political parties and is by consensus among its people. But France is deeply split on the issue. The spirit of Gaullism is antithetical to the French design to limit German power by cementing it into the architecture of the Maastricht treaty. About Europe, Belgium is unanimous, France schizophrenic.
The other problem for France is size. Belgium is a bankable problem for Germany because it is so small. And a Belgian monetary peg with the Deutschmark places the whole brunt of adjustment on Belgium, not on the Bundesbank, because it is only the amount of foreign exchange reserves in Belgian hands that will set money supply. And Belgium, unlike France, has a large current account surplus to finance sufficient resources to hold a stable peg and control money supply.
France is unlikely to go so far as a monetary peg, and a politically fixed exchange rate between the Deutschmark and French franc wouldn't work in the same way as a peg. Absorbing a France that had failed to meet the Maastricht treaty criteria could oblige the Bundesbank to absorb the franc ad infinitum. That would boost German money supply as the Bundesbank issued Deutschmarks for French francs. Alternatively, to sterilize the impact of the influx of francs, the Bundesbank would have to sell short-term paper to absorb excess liquidity, allowing real interest rates to rise. The Bundesbank would never accept this economic risk. And chancellor Kohl, having forced German monetary union down the Bundesbank's gullet, would not be able to do the same for a half-baked monetary union with France.
So, if a politically decreed monetary union is unlikely between France and Germany, that brings us to our second question about France. Will France meet the criteria? The answer is no.
I believe that the government's task is much greater than it admits. First, the starting deficits on the general government budget and the social security account for the beginning of 1996 are likely to be higher than forecast by the government. Second, the government is underestimating its debt servicing costs in future years by 0.7% of GDP. And, third, an over-reliance on tax increases and increased social charges to plug the deficits will depress growth below government forecasts.
Let us deal with each of these in turn. I reckon that France's social security deficit will come in at over Ffr70 billion in 1995 compared with a government estimate of Ffr64 billion. And there was probably an overshoot of about Ffr10 billion on the 1995 budget deficit of Ffr322 billion. While the government claims that, without reforms, the social security deficit would have been Ffr61 billion in 1996, we think it would have been at least Ffr70 billion. So we start from a total public sector deficit for 1995 of around Ffr400 billion, or 5.2% of GDP. That means the government has further to go than it claims to meet the 3% target by the end of 1997.
The government estimates that the cost of financing debt will decrease from 3.3% of GDP in 1995 to 2.7% of GDP in 1996. That's way too optimistic, even if France grows at 2.8% in 1996, as the government forecasts. Based on my interest-rate forecasts and faster rising debt than the government admits, debt service costs will be more like 3.4% of GDP over the next two years. That means that the government's target government deficit for 1996 and 1997 will not be met without more fiscal austerity.
Finally, the new taxes and social charges will cut disposable income gains to zero. The bitterly fought-over social security measures will add 1% of GDP to the tax burden. And I don't think employment will rise by anything like the government's forecast of between 1.25% and 1.5%. So, with unemployment rising, the household savings rate will stay at 14%. All this makes the government's forecast of 2.8% real growth in 1996 look like a pipedream. I think it could be below 1%. Our glum view is substantiated by practically every indicator for the French economy, except exports. They're all pointing down, particularly consumer confidence.
It's not as if France is doing nothing right. Deregulation of temporary work has helped employment. And Juppé's social security reform does much to improve transparency and accountability in social security spending. Also, a sensible tax reform to lessen the burden of taxation on top earners and the poor is being prepared. But such reforms work slowly. Fast results are needed.
The final decision date for EMU is somewhere in the first half of 1998, when 1997 Maastricht convergence measures are finally gauged. Where will France be by then? I think it will have a budget deficit well above the 3% criterion, at around 4.4% of GDP. That rules France out of EMU from a German perspective. Germany will then obtain a postponement of EMU. France will say it's for German domestic reasons (popular opposition to giving up the Deutschmark).
Not worth a divorce
What happens in France when it becomes clear that it cannot make EMU is anyone's guess. There is no serious discussion about any credible alternative policy for France other than sticking with Germany. Politically, the end of the Franco-German axis would split the governing UDR party and fragment president Chirac's support almost as much as continuing to adhere to an EMU policy. The struggle for economic and monetary union has led to low growth and little employment, but it has absorbed 15 years of constant effort and economic sacrifice. The Franco-German axis is like a comfortable but loveless marriage - giving it up may ultimately yield a more enticing end result, but is it worth the trauma of a divorce? That makes the outcome very uncertain.
If pushed, I think that social pressures will build and France will ultimately have to go for growth once EMU has been postponed. When that happens, the French franc could fall 10% towards its ERM limit. And, the nominal spread of French 10-year bonds over German bunds would widen to between 170bp and 200bp in anticipation of higher future French inflation. And yes, French equities could perform.
David Roche is president of Independent Strategy, a London based research firm.
Page 1 of 2
Next
|
Single Page