France at a Crossroads: Hollande Reshuffles his Cabinet and his Economic Policy

Hollande_Landscape

By Eric Ramoutar.

During his two plus years in the French Cabinet, Economy Minister Arnaud Montebourg was always the Hollande administration’s most outspoken personality. Eloquent and unashamed, everyone from business leaders to fellow Socialists have had their turn in his line of fire, and in late August, Mr. Montebourg made French President François Hollande his latest victim.

Hollande has long tolerated Mr. Montebourg’s propensity for public, political theatre, but open criticism of his Presidency was one step too far, and a day after his comments, Mr. Montebourg was ousted from his post.

The Time for Change is Now

Mr. Montebourg’s criticism of President Hollande was rooted in his distaste for the recent rightward drift in the administration’s economic policy. Mr. Hollande ran a successful Presidential campaign largely by opposing German-led fiscal tightening across Europe, and his victory was interpreted as a rebuff against spending cuts as a path to sustainable growth.

But since taking office, Mr. Hollande stance on continent-wide austerity has softened considerably. Instead of focusing only on the tax and spend solutions that Mr. Montebourg advocates, President Hollande has tried to reinvigorate the French economy through corporate tax cuts and reductions in overzealous public spending. That is a far cry from the days when Hollande suggested the solution to France’s troubles was a top tax rate of 75%.

It is possible that the evolution of Hollande’s position can be interpreted as a political move to save his record low approval numbers, but the more likely explanation is that Hollande has finally become aware of the dire structural problems in the French economy. Put bluntly, France’s prospects are being choked by burdensome taxation and wasteful public spending.

In fact, France has the third highest overall tax burden in the developed world and the Eurozone’s second highest corporate tax rate. In the Tax Foundation’s International Tax Competitiveness Index for all member nations of the Organization for Economic Cooperation and Development (OECD), France finished 34th. There are only 34 OECD nations. If you want to do business in France, you’re going to have to pay.

These massive tax bills might make some sense if doing business in France was inherently better than doing business somewhere else, but unfortunately, it appears to be worse. France used to lead its European competitors in output per worker, but stringent regulations have caused productivity to slip behind both Germany and the UK. In 2013, Titan International CEO Maurice Taylor hyperbolized this point when he told Mr. Montebourg that French workers, “get one hour for breaks and lunch, talk for three and work for three.” So it isn’t just that companies are paying more to be in France, it’s that they are getting much less return on that investment. 

Those incredibly grim taxation statistics are coupled with outrageously high levels of government spending. Last year, French public expenditures as a percentage of GDP were 56.1%, the second highest level in the Eurozone. That might be understandable if all that spending was going to, let’s say, making France the best educated country in the Europe, but the French rank only 10th in the Eurozone in public expenditures on education. Indeed, the majority of growth in French public spending is due to increased social security payments to the aging French population, which, while demand boosting, don’t have the same long-term impact as investments in education or infrastructure.

Blame it on the Germans!

There many more dismal statistics that illustrate the structural vulnerabilities of the French economy, but the point has been made. France cannot recover unless important reforms are made to improve the business climate. Unfortunately, Mr. Montebourg doesn’t see that, and he is still on a campaign to convince the French people that the root of lackluster French performance is the austerity that Germany is trying to impose on Paris. 

To be fair, there is some merit to Montebourg’s claim that austerity is stifling growth. Overly draconian spending cuts are undercutting demand, and the lack of demand is bringing Europe dangerously close to prolonged deflation. If prices fall, consumers will delay current spending in hopes of further price decreases, and that will cut the bottom lines of sellers, who will in turn have to let workers go. Deflation is a vicious cycle that is made worse by public spending cuts that are too large. On a basis of pure policy, Germany should relax some of its demands.

However, the real reason that Germany should relax its austerity demands is because heavy requirements make it very easy for politicians like Mr. Montebourg to convince his people that there is no need for real reform. It’s a, “don’t blame us, Blame the Germans!” type of argument. And that argument has been tremendously successful. In fact, after signaling a shift to the right in his economic policy, Hollande’s polling numbers fell to a record low of 17%, suggesting that the French people are still unconvinced that difficult reforms are necessary.

Germany has the ability to undercut Mr. Montebourg’s attempt at stymying reform. If they were to relax their demands, announce a policy of modest public investment combined with structural reforms, they would be giving Hollande a package that he could actually sell to the French people. Juxtaposing pain with some relief would be a much easier prescription for the French people to deal with.

Until then, François Hollande will be fighting a battle on two fronts, one to save the dying French economy, and one to convince the French people that he isn’t dismantling their prized welfare state. All of Europe should be on Hollande’s side, and if the Germans were to provide an assist, he might actually have a shot at prevailing.




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