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France: Growth returns but remains structurally weak

Country Report

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Economic activity is recovering after several years of near-zero growth. But the French economy still faces many structural challenges, including a relatively weak competitive position, high unemployment and weak public finances compared to other Western European countries. 

Strengths (+) and weaknesses (-)

(+) Strong public institutions and international standing

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.

(+) Low private sector debt levels

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

(-) 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. Reforms to this extent require overcoming the resistance of strong vested interests.

(-) High government debt and deficit

In 2015, government debt reached 96% of GDP and the deficit was 3.5% of GDP. The deficit will not be brought down to 3% until 2017, four years later than originally mandated by the European Commission.

Key developments

1. Economic growth picks up but persists to be structurally low and vulnerable

After three years of near-zero growth (Figure 1), French economic activity picked up modestly in 2015 reaching 1.2% GDP growth, mainly driven by private consumption. The current upturn is largely driven by benevolent external factors such as low energy prices supporting households’ purchasing power and a weak euro benefitting exporting firms. Net exports still contribute negatively to GDP growth, as the rise in domestic demand leads to more imports. Investment increased by about 1.3% in 2015Q4, a level not seen since the start of the financial crisis in 2008. This could be a sign that the government’s €40 billion cut in payroll taxes is starting to pay off, in addition to favourable credit conditions. Structurally however, the French economy suffers from insufficient competitiveness, persistently high unemployment (above 10%) and high and increasing public sector debt. Risks to the modest economic recovery and outlook abound: the external environment could deteriorate and financial volatility could flare up caused by a potential Brexit or tense negotiations with Greece. Internally, growing polarisation, decreasing social cohesion and an increasingly influential Front National (FN) under a charismatic Le Pen signify major downside risks to growth. 

2. Economic reforms remains badly needed but momentum is slowing down 

France’s competitiveness steadily eroded over the last decade as real wages increased, in addition leading to a major squeeze of firms’ profit margins (Figure 2). Wide-ranging reforms on product and labour markets are needed to restore competitiveness, reduce unemployment and boost France’s innovative capacity. While a number of reforms undertaken in 2015, e.g. the reduction of the tax wedge and increasing competition in product and services markets[1], represent important steps in the right direction, crucial outstanding reforms (such as tackling remaining rigidities in wage bargaining, minimum wage and product markets) are necessary to bring France on a higher sustainable growth path. Major labour market reforms announced in January 2016 were watered down significantly in the face of street protests, with crucial provisions about capping severance payments being dropped, and its passing (expected mid-May 2016) is no done-deal. More ambitious labour reforms are needed to bring wage growth in line with productivity developments. On product market regulation, building on the progress made under the Macron law, efforts to remove rigidities need to be accelerated significantly. Furthermore, social cohesion is steadily decreasing, providing fertile grounds for radicalisation and further polarisation. Expectations for any additional reforms in 2016 and 2017 are low, however, as the government faces opposition from its own socialist party (PS), a resurgent Front National (FN) and president Hollande’s structurally low approval rating. Furthermore, with elections coming up in April 2017, the announced labour reforms are widely expected to be the last under Hollande’s first term. Beyond that, reform sentiment could improve as there will likely be a one-term president not burdened with re-election and focussing on his legacy. However, risks of polarisation and populist/protectionist policies could greatly intensify if the FN manages to do well or even win the presidency, as described in the Regional Study Europe.

Figure 1: Competitiveness is low, leading to low or negative contributions from net exports…
Figure 1: Competitiveness is low, leading to low or negative contributions from net exports…Source: Eurostat/INSEE
Figure 2: … and increasingly squeezed profit margins compared to peers.
Figure 2: … and increasingly squeezed profit margins compared to peers.Source: Eurostat/INSEE

3. Public deleveraging is subdued but on-target

Risks to public debt sustainability in France remain high. French public debt increased to 96% of GDP in 2015 and is on an increasing, albeit slowly decelerating, trajectory. The 2015 deficit came in at 3.5% of GDP, lower than previously expected. Due to this the deficit is expected to fall below 3% in 2017, which is in line with EU fiscal targets. While the fiscal strategy has appropriately shifted to expenditure-based consolidation, a lack of ambition to broaden and deepen the public spending review would not only leave France more vulnerable to adverse shocks, it would also severely limit the scope to proceed with growth-friendly tax policies. This could imply an increase in the public debt-to-GDP ratio to above 100% over the medium term and make France more vulnerable, even though the maturity structure of public debt and current financing conditions should provide for some resilience.

4. Financial sector’s foreign exposures continue to be a key risk

The French banking sector is dominated by a handful of very large, internationally active banks whose reliance on wholesale funding is large compared to peers. The evolution of possible risks stemming from their systemic importance, e.g. interconnectedness, substitutability, complexity and cross-jurisdictional activities, could lead to negative spillovers.

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

[1] Known as the Tax Credit for Competitiveness and Employment (CICE) and its supplement, the Responsibility and Solidarity Pact.

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 2015). Despite being a widely liberalised economy, the government plays a significant role, as government spending is traditionally an important growth driver. Furthermore, the government owns shares in companies in a wide range of sectors while the labour market, including wage formation, is highly regulated. In fact, France’s labour market is ranked 51st according to The Global Competitiveness Report 2015-2016 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 combined with an insufficient focus on innovation undermine France’s competitive position. On product market regulation France is also very rigorous with many regulated professions and severe disincentives for SME’s to grow beyond the threshold of 50 employees. Reforms that liberalise the French economy are crucial, but are not expected in the short term as France has a poor history of implementing structural reforms. Some liberalisations took place in 2015 and 2016 but are overall expected to be too limited to have a significant positive impact. 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 pensions. In addition, 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 
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Author(s)
Daniel van Schoot
RaboResearch Netherlands Rabobank KEO
+31 30 21 62666

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