France is Europe’s largest time bomb

Published in Business Spectator (Melbourne), 3 April 2014

By all measures, it was a defeat of historic proportions for President François Hollande and his Socialist Party. Last weekend’s French local elections have turned the country upside down, or rather shifted it to the political right. It is also a reminder that of all the time bombs ticking in the eurozone, France remains the largest and least predictable.

In summary, Hollande lost 171 town halls in cities with more than 9,000 inhabitants. This included strongholds which the left had governed for over a century. The final national result saw the centre-right on 45.9 per cent, the socialists and their allies at 40.6 per cent and the populist right-wing National Front at 6.8 per cent. Though the latter may not sound too dramatic at first, the real strength of the National Front is several times larger since it only ran in a small number of cities, winning majorities in 11 of them.

A day after the election, Hollande pulled the emergency brake and dismissed his government. Prime Minister Jean-Marc Ayrault had to go and in his place Interior Minister Manuel Valls was installed. But in France’s presidential democracy, in which the President calls the shots and the ministry hardly matters, it remains an almost symbolic act — a desperate measure of a desperate President.

Despite the new Prime Minister’s personal ambitions and his popularity, little will change as a result of the reshuffle. As long as François Hollande remains in the Élysée Palace, which is until 2017, he will determine the direction.

The real question therefore is: Does the President actually have an idea about where to take his country? Or will we see another three years of political drifting and economic standstill in the eurozone’s second largest economy?

Unfortunately, if Hollande’s first couple of years are anything to go by, there is not much reason for optimism. His record is poor, his popularity at record lows, and apart from repeated promises to change tack, he has not delivered the kind of reform agenda that France desperately needs.

To underline the seriousness of France’s condition, the day the President fired his government brought more bad news from the economy. The national statistical office Insee published the official national debt and deficit figures for 2013. Total government debt at the end of last year was EUR1.925 trillion, 93.5 per cent of GDP. The annual deficit at 4.3 per cent of GDP, though down from 4.9 per cent the previous year, was still worse than the government had expected. Both the debt and the deficit figures are in violation of the Maastricht Treaty rules, which supposedly govern eurozone governments’ behaviour.

Behind the grim public finance data lies an overall sluggish economy. On Monday, Insee also released data showing that economic growth in 2013 was a meagre 0.3 per cent. If you are an optimist, it was a step in the right direction since in 2012 the French economy was stagnant. More realistically however, it shows that there is hardly any dynamism. The last time there was any meaningful growth in the economy was in the first quarter of 2011, when the economy expanded (quarter-on-quarter) by 0.9 per cent. Ever since, GDP has effectively remained stagnant with the growth rate oscillating around zero.

The picture gets even darker when dissecting the sources of French growth. In 2013, the single largest factor was general government consumption expenditure, which shot up by 1.8 per cent. Meanwhile, private households were squeezed by government’s appetite. Their modest wage increases were almost completely wiped out by tax increases and social security contributions.

To round off the bad news, unemployment remains stubbornly high. Last month it reached a record number of 3.348 million people without a job – a rate of 10.9 per cent. This is now more than twice as high as in France’s neighbour to the east, Germany.

Given this economic background and President Hollande’s apparent inability to implement any reforms, it is hardly surprising his side did so poorly in the local elections. If anything, it could have been a lot worse. Indeed, it might still get worse for him next month at the European Parliament elections. In a recent opinion poll, Hollande’s socialists were only the third largest party (19 per cent) behind the National Front (22 per cent) and the conservative UMP (24 per cent).

With his change of government, Hollande is trying to avoid such a scenario. His new Prime Minister Valls is someone who might appeal to conservative-leaning voters. Whether that alone will be enough to stop voters from once again expressing their frustration with the President’s economic record remains dubious though.

After just two years in the job, France’s President already looks like a lame duck. His personal approval ratings are below 20 per cent. At the moment he needs to mobilise all his political capital to get France moving again, he has none. His own party is unlikely to follow its struggling leader, especially as some are already speculating about alternative candidates for 2017, including the newly appointed Prime Minister.

Until the next presidential election there will be three long years with a weak, unpopular Hollande presiding over an ailing French economy. On its current trajectory, debt to GDP will have reached 104 per cent of GDP by 2017 according to Oxford Economics. Even this forecast may turn out too optimistic since it still assumes annual growth rates between 1.1 per cent and 1.3 per cent for the coming years and a steadily shrinking annual deficit.

If France does not manage to escape its current trajectory, the country will remain vulnerable to economic shocks. It could also see its credit rating downgraded. And it remains prone to political instability.

None of this is good news for the eurozone. The policies of the ECB and the various bailout packages have calmed down the euro crisis at the periphery. Such measures would not be sufficient for a country the size of France. Should markets start to get concerned about France’s long-term public finances (as they should), the euro crisis would enter a new phase.

To avert this fate, it requires not just a new French government but a new French president.

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