France at Risk

France at Risk
April 11, 2012
Bill Witherell

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This commentary was written by Bill Witherell, Cumberland’s Chief Global Economist. He joined Cumberland after years of experience at the OECD in Paris. His bio is found on Cumberland’s home page, www.cumber.com. He can be reached at Bill.Witherell@cumber.com.

The French economy, the second largest in the Eurozone and considered to be a critical part of the “core,” is increasingly seen as “struggling.” Fundamental structural deficiencies that are continuing to gnaw at France’s ability to compete internationally are now being emphasized in a presidential election campaign in which both leading candidates are making election promises that, if fulfilled, would surely make it even more difficult to tackle France’s economic problems. And this is occurring at a time when the Eurozone’s sovereign debt crisis is far from being resolved and much of Europe is in recession. Industrial production declined in February, the third month of declines.

On the positive side, France has more firms in the global Fortune 500 than any other European country. But French companies are struggling to compete with labor costs 10% higher than those for German firms and social charges double those that German firms face. A European Commission survey suggests that French firms also have an innovation deficiency. It perhaps is not surprising that France’s unemployment rate is 10%, compared to 5.8% in Germany.

France is no Greece with respect to public finances, but its finances are going in the wrong direction. Its public debt is 90% of GDP and increasing at a time when the rest of Europe is recognizing the need to take tough austerity measures. In a thoughtful editorial entitled “A Country in Denial,” in the March 31st issue of The Economist, decades of French policies are summed up as follows: “For years France has offered its people a Swedish-style social model of services, benefits, and protection, but has failed to create enough wealth to pay for it.”

Having spent 27 years in France while working at the OECD in Paris, a beautiful city and country, it is with regret that I must agree with The Economist’s views on some of the reasons France has fallen behind in the creation of wealth. Too many of the French reject the free-market system and capitalism. A poll by the polling firm GlobeScan indicates that only 31% of the French agree that the free-market system is the best. Business- and market-friendly reforms face a very strong political headwind in such an environment. The French have never come to terms with the globalization of the world economy, and their attempts to resist globalization have failed.

The leading two candidates in the Presidential campaign, the Gaullist President Nicolas Sarkozy, and the Socialist contender, Francois Hollande, have contributed little to address France’s dire economic problems in their campaign speeches. Indeed, most of their statements have only served to raise investor concerns, including ours, about France’s future. This is especially the case for the Socialist Hollande, whom polls suggest is in the lead. He is calling for an increase in the size of the state (public spending is already equal to 55.8% of GDP), a roll-back of part of Sarkozy’s pension reform, and for taxing the rich at a 75% top tax rate, which would rise to over 90% when social charges are included. He also wants to increase the wealth tax and taxes on dividends.

Most worrisome with respect to Sarkozy is his calling for the adoption of protectionist policies. His plan for addressing the public finance crisis would increase the burden of taxes to 45.8% of GDP by 2016 from 44.6% today. On the positive side, in his economic program unveiled last week he aims to reduce public spending as a proportion of GDP to 51.9% by 2016. He also says he will seek to reduce high social charges and liberalize the French labor market.

We recognize that election promises often are not fulfilled and there will be great pressure on whomever is elected to address France’s problems in a realistic and responsible way. For example, while a number of market-unfriendly steps were taken, such as the mandatory 35-hour week, during the Socialists’ previous turn in power, there were also positive steps. Over the 1997-2002 period more French companies were privatized than had been up to that time. We do hope wiser views than we have heard expressed in this campaign will prevail. France is fortunate to have one of the globe’s best central bankers in our friend Christian Noyer, Governor of the Banque de France, along with a goodly number of sound economic and regulatory officials. Nevertheless, we view the coming years for France with great concern.

Investors are registering their concerns in the markets. French equities are underperforming this year. The MSCI equity index for France, with a year-to-date increase of 3.6%, is far behind Germany’s 12.4% advance. While Germany’s bond rate has been declining, France’s has been rising; and hence its spread over the German benchmark has increased to 1.31%, the highest it has been since mid-January. Of course that is still far less than Spain’s 4.25% spread and Italy’s spread that is approaching 4%. Within the Eurozone, we have concentrated our positions in our Global and International portfolios in just one equity market, that of Germany.

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Bill Witherell, Chief Global Economist