Despite possessing one of the world’s top economies, France has been grappling with relatively low growth and stubbornly high unemployment for a number of years. The sluggish performance of the French economy is in sharp contrast to that of its neighbour Germany, which has bounced back strongly since the end of the financial crisis (see chart below).
People lack incentive to work
Much has been said about rigid labour laws stifling productivity growth, and the lingering power of the unions compared to other countries. In an era of global economic liberalisation, this has hindered modernisation and reform measures, becoming a poisoned chalice for any government attempting to tackle the issue.
A high tax burden and a generous social security system creates a disincentive to work, whilst an inflexible labour market and rising unit labour costs have resulted in a further loss of competitiveness, primarily to more efficient economies such as Germany, but also to countries that did enact painful structural reforms in the recession that followed the financial crisis. Unemployment remains stubbornly high, with the jobless rate having been at or around 10% for much of Hollande’s tenure (the youth unemployment figure is said to be much higher).
Excessive taxation of the wealthy has also been a criticism of the current government, with many leaving the country and therefore depriving the state of crucial tax revenue.
France may be shouldering an unfair Euro burden
Whilst France has some world-class industries, it has accumulated a trade deficit of around EUR 48bn compared to Germany’s trade surplus of approximately EUR 253bn. This has often prompted the debate that some Eurozone members have benefited from the common currency at the expense of others.
A recent European Commission report highlighted this, suggesting that the French economy was improving but still had excessive imbalances whilst being critical of Germany’s burgeoning current account surplus which has reached approximately 9% of GDP - far in excess of other export-led nations such as China and South Korea.
The public sector is inflated
Another often-cited weakness of the French economy is the size of the state relative to the economy as a whole. At 57% of GDP, France has one of the highest public sector spending ratios in the developed world and is significantly higher than the Eurozone average.
Whilst this acted as a cushion during the post financial crisis downturn, it has been a subsequent impediment to growth, with the IMF repeatedly warning that this issue lies at the heart of France’s fiscal problems.
Tourism took a hit after terrorist attacks
As the world’s leading tourist destination in terms of numbers, there has undoubtedly been an economic cost associated with the numerous terrorist attacks the country has suffered over the past few years and the subsequent reticence of foreign nationals to visit.
Tourism has always been an important component of the economy, with the direct contribution of travel and tourism estimated at approximately 3.6% of the country’s Gross Domestic Product (GDP) and the total contribution (direct, indirect and induced) in the region of 9% of GDP. Early indications are that visitor numbers are recovering in 2017, therefore, this should bolster growth going forward.
The political future is uncertain - bond yields are rising
With the soon-to-be departure of Francis Hollande, one of France’s most unpopular leaders in history according to polls, the current political landscape in France is very uncertain. The rise of anti-establishment parties across Europe has unsettled investors and Francois Fillon, the presidential candidate many assumed would beat Marine Le Pen, has been faltering following accusations that he used state funds to pay family members to do fake jobs. Given that Marine Le Pen has talked about restoring the Franc, her presidential bid poses an existential threat to the future of the Euro.
The current uncertainty surrounding the presidential elections is one of the factors that has caused French Government bond yields to rise recently. The divergence between France’s ten year government bond yield and that of Germany has risen to approximately 0.8%. Given that Germany is essentially the Eurozone ’risk free’ rate, this suggests that the markets are increasingly nervous about the prospect of a Marine Le Pen victory. However, it should also be noted that there are broader factors at play also, with the potential tapering of quantitative easing by the European Central Bank as growth and inflation both pick up.
The worst-case scenario for markets appears to be a run-off between Marine Le Pen and a possible joint candidacy coming from the left between Socialist Benoit Hamon and far-left campaigner Jean-Luc Melenchon. This outcome seems remote however, with Hamon and Melenchon unable to reconcile their differences at present, despite trailing in the polls individually. The latest polls point to a showdown between Marine Le Pen and either Francois Fillon or Emmanuel Macron.
The latest forecasts from the European Commission indicate that whoever the next president is, he or she faces a showdown with Brussels regarding the failure of France to adhere to Eurozone budgetary rules, namely the stability and growth pact, which aims to keep budget deficits below 3% of GDP.
Outlook for French economy remains hopeful
Despite all these challenges, there are signs that the French are willing to take the steps necessary to tackle their fundamental economic problems. To do so, compromises will need to be made to enact structural reforms, with curbs to an overly generous social welfare system and a loosening of protections for workers high on the agenda.
The UK’s eventual exit from the European Union also presents an opportunity to lure back tax exiles (many of whom found their way to London) and make Paris the new centre for multi-national banking operations in Europe, should the UK lose its passport rights.
Capital International Group