RaboResearch - Economic Research

Country Report France

Country Report


Flag France

In the short-term, low oil prices and the weak euro will support economic growth. But the French economy also faces many structural challenges, including a relatively weak competitiveness position, high unemployment and weak public finances compared to other Western European countries. 

Strengths (+) and weaknesses (-)

(+) Low private sector indebtedness

French household and corporate debt is relatively low, and private sector savings are relatively high compared to other eurozone countries.

(+) Strong public institutions

French infrastructure is among the best in the world, and the country benefits from a high degree of technological adoption. Furthermore, potential growth is supported by the quality and quantity of the education system.

(-) Labour market rigidities and low corporate profit margins

Structural rigidities in labour markets combined with comparatively low corporate profit shares have diminished business innovations, thereby undermining the economy’s growth potential and contributing to a loss of export performance.

(-) High government debt and deficit

In 2014, government debt reached 95% of GDP and the deficit was 4% of GDP. Although public spending is being cut, the deficit will probably not be brought down to 3% until 2017. This is four years later than originally mandated by the European Commission (EC), and reflects both the inability and unwillingness of the government to bring government finances back in order.

Key developments

1. Economic growth strengthens somewhat, but remains weak

After three years of slow activity (figure 1, average growth was 0.4% y-o-y in 2012-2014) the French economy is projected to gain some strength during 2015 and 2016. Low oil prices and a tax reduction for low incomes support households’ purchasing power. Furthermore the low value of the euro against all major currencies supports French exports outside the eurozone. Investment growth is expected to pick up slightly in 2015, after a decline of 1.6% y-o-y in 2014, on the back of stronger aggregate demand and favourable credit conditions. Reforms intended to decrease the costs on labour, like the CICE[1] and the responsibility pact, will likely further boost investments from 2016 onwards. But it’s not all good news, as an already announced cut in public spending of €50 billion from 2015-2017, to fund the responsibility pact, and additional spending cuts of €9 billion in 2015 and 2016 will weigh on growth. The economy also suffers from a high unemployment rate. Potential risks to the fragile economic recovery are a Grexit and/or an escalation of the conflict in East-Ukraine, as both can negatively influence consumer sentiment. An increase in oil prices might also pose a downward risk on the recovery by suppressing households’ purchasing power.

2. Pro-business policy reforms difficult to implement

Since real wages increased substantially during the past decade, France has lost price competitiveness (figure 2). In order to restore its competitive position and transform France from a consumption-driven economy into an export and investment driven economy, a wide-ranging liberalisation of the labour market is crucial. Several minor reforms are expected before the summer of 2015, including a social dialogue and a Macron 2 law on SMEs, investments and digital technology aimed at helping private investment through regulatory and legal simplifications. These reforms are steps in the right direction, but they are unlikely to be sufficient to tackle the structural challenges France is facing. Additional major reforms are, unfortunately, not expected for two reasons. First, the reform ability of the government is limited by the opposition of the left wing of the ruling socialist party (PS) and Hollande’s historic low popularity levels. The latter is reflected in the PS’ great loss in the March departmental elections. The former is reflected by the enforced passage of the Macron-law by using a confidence vote. The pro-business law contained only minor measures, most importantly the liberalisation of certain regulated professions, allowance of working on Sundays and changes to redundancy procedures. Second, in light of the presidential elections in 2017 and pressure from within the PS, Hollande is likely to slow down rather than step up the reform pace from 2016 onwards in order to unite the left wing of the PS.

Figure 1: GDP growth
Figure 1: GDP growthSource: Eurostat
Figure 2: Unit labour costs remain high
Figure 2: Unit labour costs remain highSource: Eurostat

3. Public deleveraging remains subdued

French public debt increased to 95% of GDP in 2014 and the government does not seem to prioritise debt reduction. However, the 2014 deficit came in at 4% of GDP, lower than the previously expected 4.4%. Due to this, the French Finance Minister Sapin revised the 2015 budget deficit target down from 4.1% to 3.8% of GDP. France plans to cut its public deficit to 3.3% of GDP in 2016, and to bring it under the EU’s cap of 3% in 2017, which is in line with newly agreed EU fiscal targets. However, the EC demands larger structural cuts in 2016-17 than France is planning in order to reassure economic growth. This would mean that France misses its budget deficit-reduction targets again and therefore risks a penalty from the EC and increased tensions with peers.

Despite high government debt and deficit the French government maintained good access to the bond market. France’s debt affordability is supported by low funding costs, the strong financial position of the private sector and high government revenues (47% of GDP in 2014), although the latter possibly leaves little room for tax increases. Furthermore, debt-payment risks are limited by the favourable debt profile, as average maturity is around seven years and interest rates are very low. However, given France’s weak fiscal track record, the uncertainty of deleveraging public debt and the weak economic outlook, the government may lose investor confidence and thereby debt affordability. It is therefore essential for the French government to improve its fiscal stance.

4. Lack of integration of France’s Muslims leaves the country vulnerable over time

After the terrorist attacks in Paris in January 2015, government focus shifted somewhat towards security policies, but the government probably won’t deal sufficiently with the lack of integration of France’s Muslims and other minorities. This leaves the country vulnerable over time and poses a downward risk to the rating.

Factsheet of France
Factsheet of FranceSource: EIU, CIA World Factbook, UN, World Economic Forum, Transparency International, Reporters Without Borders, World Bank.

[1] Competitiveness and Employment Credit. A tax credit which reduces social contributions for firms.

Background information

France is the world’s fifth and Europe’s second largest economy in terms of nominal GDP. The country benefits from very good infrastructure and high quality of the education system. French economic growth has been primarily driven by domestic consumption in the last decade. The weak position of French public finances is compensated by the solid balance sheet of the private sector, as households possess large net financial assets (over 150% of GDP in 2013).

Despite being a widely liberalised economy, the government plays a significant role in the economy, as government spending is traditionally an important growth driver. Furthermore, the government owns shares in companies in a wide range of sectors whilst the labour market, including wage formation, is highly regulated. In fact, France’s labour market is ranked 61th according to The Global Competitiveness Report 2014-2015 because of strict firing and hiring rules and a highly distortive tax system. Due to sharp rises in non-wage costs such as social charges, French nominal wage costs are among the highest in the euro-zone. These labour market rigidities combine with an insufficient focus on innovation to undermine France’s competitive position. Reforms that liberalise the French labour market are crucial, but are not expected in the short term as France has a poor history of implementing painful structural reforms. Notwithstanding the fact that France’s aging problem is expected to be relatively mild compared to other European countries, it remains an important challenge to keep control over age-related spending. Especially since the labour participation rate in France is among the lowest in Europe and public debt is still on an increasing path.

Economic indicators of France
Economic indicators of FranceSource: EIU
Carlijn Prins
RaboResearch Netherlands, Economics and Sustainability Rabobank KEO
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