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France in the Eye of the Eurostorm

Arthur Goldhammer

Syracuse, Sept. 21-22, 2012

Draft: Please don’t quote or circulate without permission

Comments welcome: art.goldhammer@gmail.com

When Standard & Poor’s downgraded the credit rating of France along with eight other

European countries on January 13, 2012, some observers drew the conclusion that France, with

its banks possibly exposed to severe losses on plummeting Spanish, Italian, and Greek sovereign

debt, was at the eye of the Eurostorm. If one of the twin motors of the Eurozone, indeed of the

European Union, stalled in the maelstrom, then how could the euro or the Union survive?

Just eight months later, the picture looks rather different. The pessimists once again

underestimated the resourcefulness of the European Central Bank, the cunning of its new leader,

Mario Draghi, and the well-camouflaged but very considerable adroitness of Angela Merkel.

With a second Long-Term Refinancing Operation (LTRO) in March of 2012, followed by

Draghi’s announcement in August of the ECB’s intentions to intervene directly in the secondary

market for sovereign debt, fears of imminent French fiscal difficulty have dissipated. Indeed,

France can now borrow short term at negative interest rates, a consequence of capital fleeing the

troubled south and finding safety in French repositories.

To conclude from these facts that the Eurostorm has in fact passed over France would be

premature, however. A deeper examination of the French position reveals reasons for

considerable worry. The crisis has imposed serious constraints on French economic policy. At

the same time, it has created an opportunity for revision of the French tax system and labor

codes, which some would argue is needed to address a long-standing decline in France’s

competitive position within the EU and in the wider world. If the new Socialist government

avails itself of this opportunity, however, it is likely to arouse a storm of protest within France,

most notably among people who voted for Hollande in this year’s election precisely because they

had turned against Sarkozy’s on-again, off-again neoliberal reforms. Furthermore, a long-term

solution to the euro problem will entail a modification, not to say surrender, of French fiscal

sovereignty that presently finds little political support in any quarter of the French political

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compass. Yet Germany is likely to insist, not immediately but at some point in the future. on a

more powerful federal authority within the EU. In short, what began as a currency crisis is, in my

view, likely to become a full-blown and possibly insoluble crisis of European governance. From

the euro crisis to the EU crisis might therefore be the subtitle of this essay.

Anomalous France

Students of the “varieties of capitalism” have long conceded that France does not

conform well to either of their primary models; it is neither a liberal market economy (LME) nor

a coordinated market economy (CME) [Hall and Soskice, etc.]. The crisis has emphasized a

different sort of cleavage, along north-south lines, with northern economies such as Germany,

the Netherlands, and Austria faring relatively well compared to southern economies such as

Portugal, Spain, Italy, and Greece, with Ireland granted honorary southern status to round out the

group collectively known by the unattractive abbreviation PIIGS (or sometimes GIPSIs).

France doesn’t fit neatly in this second classification either. Although, like Greece, it has

often sinned against neoliberal orthodoxy with market-distorting programs intended to buy social

peace, such as youth employment subsidies, early retirement incentives, a shortened work week,

generous medical coverage, onerous layoff procedures, and a labor code that encourages

dualism, unlike Greece it taxes its citizens commensurate with the benefits it provides. To be

sure, French governments of both the left and right have generally failed to balance their budgets

for the past twenty years, but France has been no worse than Germany in its violations of the

Maastricht criteria (budget deficit under 3% of GDP, debt/GDP ratio under 60%). Its banking

sector was more conservative than the German, avoiding exposure to toxic American subprime

debt, and it did not underwrite construction booms such as those that brought down the

economies of Spain and Ireland. To be sure, French banks did lend to peripheral countries,

especially Spain, thus helping to prime the hyperactive Iberian pump, but they did so in such a

way that they were for the most part able to extricate themselves without undue damage, albeit

with considerable help from the ECB’s LTROs.

France did not resemble the northern economies in another, less positive, respect

however. Its trade position deteriorated continuously over the course of the 2000s, whereas

Germany’s improved steadily over the decade and sharply after the completion of the Hartz

reforms in 2005. Germany, obliged early on to cope with the fiscal shock of reunification,

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undertook these painful and unpopular reforms to strengthen both its fiscal position and its

export machine. More importantly, it benefited from the coordinated wage bargaining embedded

in the economic culture of this paradigmatic CME. Having restrained wage growth during the

euro’s boom years, it was in a better position to weather the subsequent shock of the subprime

collapse and the revelation of serious imbalances in the Eurozone.

The graph above shows the deterioration of the French balance of payments from positive

in 2001 to neutral by 2005 and negative in 2010. Italy’s balance of payments followed a similar

downward course, but Italy had to cope with an increase in its effective exchange rate (foreign

goods became relatively cheaper in Italy, Italian goods became more expensive elsewhere in the

Eurozone), whereas France did not. Of course, this difference could itself reflect deeper

problems in the Italian political economy, which has allowed wages to increase more rapidly in

France over the euro’s first decade.

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Yet in some respects Italy finds itself in a stronger position than France at this point in

the evolution of the crisis. Its primary budget balance (net of interest payments on government

debt) was estimated by the IMF at +3.0, whereas France is running a primary deficit of -2.2.

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To be sure, the fact that Italy is running a primary surplus may simply reflect the fact that

Italy has a higher debt/GDP ratio than France (120% vs. 90%), and France’s borrowing costs are

much lower than Italy’s, with a spread on the 10-year bond of just 62 basis points over the

German bund at this writing versus 348 basis points for Italy (and 430 for Spain). So one can

look at the French government’s fiscal position as a glass half-empty or half-full, depending on

one’s temperament. As long as capital continues to flee the PIIGS, and as long as the quantitative

easing policy of the US Federal Reserve continues to encourage portfolio managers to leave

substantial sums in euros, France will reap the rewards of the flight to safety.

Of greater concern, however, is the long-term deterioration of France’s competitive

position. France continues to do well in capital-intensive industries such as chemicals,

pharmaceuticals, insurance and financial services, aviation, avionics, high-speed rail, nuclear

power, and certain sectors of high-technology, such as applications of the laser. It has been

losing ground, however, in more labor-intensive industries such as automobile manufacturing

and textiles (although it remains a leader in the quasi-artisanal luxury-goods sector, as well as in

global retailing thanks to the reach of the commercial giant Carrefour). Many of its small to

medium firms are antiquated, unlike their German competitors, in both technology and

management practices.

To get a clearer picture of what is going on, let us look at one subcategory of the

Standard International Trade Codes, group 7 (automobiles and transport equipment).

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To be sure, France has long been a net importer in this category from Germany, but note

the serious deterioration of the French position vis-à-vis both Spain, most notably, and Italy over

the last decade. Yet Italian and Spanish unit labor costs in manufacturing rose faster than

France’s:

I will return later to the deeper reasons for the decline of certain sectors of French

manufacturing industry. It is important to note, however, that although France remains a prime

destination of foreign direct investment, which goes mainly to its capital-intensive export sector,

and itself invests considerable sums abroad, especially since the liberalization of controls on

capital in the 1990s (well-described by Pepper Culpepper [2010] and Rawi Abdelal [2009]),

capital formation in the labor-intensive sector has lagged, resulting in chronic unemployment:

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A Deliberately Cultivated Ambiguity—Or Is it Ambivalence, or

Indecisiveness?

With this rapid overview of France’s economic situation in mind, let us now consider

what the Socialist president, elected in May 2012, might wish to do about it. During the

campaign, he repeatedly promised to renegotiate the fiscal pact agreed to in private on March 2,

2012, by German chancellor Angela Merkel and then French president Nicolas Sarkozy—a pact

often derided in the press as “the Merkozy accord,” which made aid to troubled Eurozone

economies contingent on the implementation of strict austerity measures. These were to be

written into national constitutions, following the example of the German balanced budget

amendment.

Hollande’s apparent opposition to this pact, together with his advocacy of jointly-issued

Eurobonds and a European Investment Bank to be richly capitalized with funds from an

unspecified source, made him briefly the titular head of a supposed “anti-austerity coalition”

within the Eurozone. Although the French candidate had little interest in denying that he would

be the bearer of “hope and change,” any reader of his platform could see that he also promised to

meet the conditions imposed by “Merkozy”: he would bring the budget deficit under 3% by 2013

and balance the budget by 2016, and he would do this despite promises to hire 60,000 additional

schoolteachers and an untold number of additional policemen.

Now in power, Hollande has maintained his commitment to austerity. He will not,

however, risk a ratification vote on the Merkozy agreement, now more respectfully referred to in

the press by its proper name, the Treaty on Stability, Coordination, and Governance. Indeed, the

European Union has never been more unpopular in France: a recent poll found that if the French

were asked to vote today on the Maastricht Treaty, which they approved in 1992 by a scant 51%,

only 36% would vote in favor.

There is in fact a deliberately cultivated ambiguity in Hollande’s stance on the two key

(and interrelated) issues he faces: how to manage the economy, and what attitude to take toward

the future of Europe. Throughout his career he has positioned himself as a staunch European, a

true disciple of his two mentors, François Mitterrand and Jacques Delors. As head of the

Socialist Party for eleven years, he tried to straddle all factions on most issues but came down

firmly in favor of ratification of the European constitutional treaty in 2005, against the man who

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is now his foreign minister, Laurent Fabius, and against the rival for the presidency who is now

his minister for “productive reinvigoration,” Arnaud Montebourg, both of whom campaigned for

the victorious “No.” But Mitterrand’s commitment to Europe was geopolitical, not economic;

what concerned him most was binding Germany to Europe, and if accepting a central bank

tailored to German desires was the price of achieving that goal, Mitterrand was willing to pay it.

As for Delors, the architect of the euro, he knew that his creation was flawed in that it lacked

several of the features that economists insisted were necessary to make a single currency work

(including a central fiscal authority, transfer payments between regions, labor mobility, common

labor regulations, and harmonized social security systems). Yet he was willing to take the risk

rather than lose the momentum toward a closer union. Posterity could be trusted to repair the

flaws.

Hollande, who is basically a realist despite occasional outbursts against “the rich,” whom

he once professed to “hate,” and the “world of finance,” which he once branded his “only

enemy,” knows that France, which must borrow in a currency it does not issue or control, cannot

defy the markets. He was a young staffer in Mitterrand’s administration in 1983, when French

Socialists discovered that socialism (or even Keynesianism) in one country could not be made to

work in a world turning toward Reagan and Thatcher’s neoliberalism. He also knows that

France’s tax bite is already the largest in Europe, and that the “tax wedge” is a factor in France’s

loss of competitiveness.

To address the latter point, he has already proposed a revision of the Contribution Sociale

Généralisée (CSG), a broad-based tax established by a previous Socialist government to help

reduce the social security deficit. Payroll taxes now paid by employers will be shifted to the CSG

in a revenue-neutral way, reducing the burden on labor. This may (or may not) be part of a

“balanced-budget stimulus” plan of the sort advocated by Joseph Stiglitz for countries in

France’s situation, unable to finance stimulus by deficit spending. Hollande, unlike his

counterpart David Cameron in the UK, is certainly not ideologically committed to the

“expansionary contraction” advocated by some economists such as Alberto Alesina but derided

by others such as Paul Krugman and apparently refuted by the recent evidence of European

recession. In any case, the “confidence fairy” has yet to be spotted anywhere on the Continent.

But the CSG revision by itself is unlikely to spur much if any growth in France. Hollande has

also proposed a more classically socialist or solidaristic jobs program in the form of an

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“intergenerational contract,” which will pay subsidies to firms that hire unemployed young

workers and retain older workers to train them. One may question, however, whether this

program is well-adapted to today’s environment of rapidly changing production processes.

Ultimately, however, the problem with French competitiveness has less to do with labor

costs and tax wedges than with the strategies of French capital and the push and pull of the

French political economy. The increase of French automobile imports from Spain, for example,

can be accounted for by German investment in Spanish auto manufacturing. Volkswagen bought

the Spanish firm SEAT and took advantage of lower Spanish wages to produce cars that would

sell at a lower price point in France than standard German imports. It thus increased its market

share at the expense of the French firm PSA, which has now been forced to close its plant at

Aulnay, ultimately idling some 8,000 workers. PSA had earlier attempted to emulate the German

model by restructuring its supply chain to shift some labor-intensive functions to Eastern Europe.

It was prevented from doing so by the Sarkozy government, which, abandoning its neoliberal

principles, summoned PSA executives and berated them for ingratitude for moving to outsource

production after having accepted stimulus money from the French government in 2008. PSA

simply delayed its plant closure until after the election, however, although in the interim its

position had deteriorated to the point where it also scrapped plans to move some production

processes outside of France [Sartorius Report, 2012].

This ambivalence about industrial strategy in a neoliberal single market has hampered

French adjustment to rapid changes in the production regime. Financial capital now moves

freely, but fixed capital is trapped in traditional and decreasingly profitable relations with fixed

labor. Existing jobs are protected until it is no longer possible to do so, leaving workers suddenly

jettisoned onto the labor market unprepared for the kinds of new industry that might be created,

and which the government has attempted to encourage by fostering closer relations between

industry and academic scientific research, for which a good part of the billion euros raised

through Sarkozy’s Grand Emprunt (Big Loan) was earmarked.

What Hollande has in mind to promote such startups raises serious questions, however.

Having failed to win the cooperation of Germany on a European Investment Bank, he has fallen

back on a French Investment Bank, which is supposed to invest in French projects. But two key

ministers, Montebourg at Productive Reinvigoration and Moscovici at Finance, are at odds about

how much capital to invest in this bank (Montebourg is asking for an inconceivable 100 billion

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euros, while Moscovici prefers as little as one-tenth that amount). Others point out that the

proposal to have bank branches cooperate with regional governments (nearly all of which are

Socialist-controlled in France today) raises the possibility of a cozy crony capitalism in which

regional political bosses finance pet projects through the regional branch of the national

investment bank. The dangers of such arrangements have been recognized in Germany and Spain

as well as France, and the track record of this sort of hybrid public-private industrial policy in

France is not encouraging.

Hollande, anticipating opposition in any case to the likely consequences of his budgetary

squeeze, has tried to buy himself some goodwill by offering small tokens to potentially hostile

groups. To the extreme left, the restive portion of his winning presidential coalition, he offered

the symbolic prize of a 75% marginal tax rate on individuals earning over 1 million euros per

year: Faire payer les riches, once the slogan of the Communists, is again d’actualité. But there

are only 2 to 3,000 of these riches in France today, according to the Finance Ministry, and the

tax will raise under 1 billion of the 36 billion Hollande needs to reduce the budget deficit to the

promised 3% of GDP within a year. What’s more, the tax has already been watered down by the

decision to apply it to individual incomes rather than (larger) household incomes and to exclude

capital gains and stock options; furthermore, it is only a temporary tax, set to expire in two years.

More surprisingly, Hollande issued a ban on exploratory “fracking” projects in the south of

France. A more cautious approach would have been to refer the issue to a commission for further

study, but Hollande, by making what appears to be a definitive decision to ban fracking in

France, has pleased the Greens. And his interior minister, Manuel Valls, has continued Sarkozy-

era crackdowns on illegal Roma encampments. In another gesture to law-and-order proponents,

he has established special security zones throughout the country. These are to receive additional

police and funding for more intensive law-enforcement. Preliminary discussions have begun with

the “social partners” (capital and labor) over proposed labor market reforms as well, but the

details remain shrouded in secrecy.

The most important decision facing Hollande at this point, however, is how to respond to

anticipated German proposals concerning the future governance of the European Union. Draghi

has warned that his extraordinary bond-purchase measures, in which Merkel has acquiesced for

the time being, are not the definitive solution for the euro crisis. He believes, as Delors believed,

as many German authorities as well as economists argued before the euro’s inception, that the

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currency union cannot survive without—at a minimum, leaving aside more expansive measures

alluded to above—a mechanism for enforcing budget discipline in member states, for issuing

bonds at the European level, and therefore for collecting taxes or providing for contributions

from member states to finance those bonds. In the negotiations leading up to the euro, France

opposed such institutional changes and jealously guarded its fiscal sovereignty. On this point

Hollande’s two mentors, Mitterrand and Delors, diverged. It is impossible to predict which way

Hollande will turn, and indeed it is impossible to say whether Merkel will actually propose

anything like a bold step toward fiscal union, given that sentiment toward the EU in Germany

right now is even more negative than in France. She faces an election next year and has shown

herself to be exceedingly cautious to this point. Nevertheless, because the flaws in the single

currency are now so glaring, and the possibility that the ECB’s legerdemain will at some point be

tested and found wanting, it seems likely that quiet discussions will proceed behind the scenes in

preparation for a recasting of European institutions when the political moment is more

propitious. In the meantime, Hollande, heeding the voice of his mentor Mitterrand, stronger than

that of his other mentor Delors, will in my view attempt to placate Germany by maintaining tight

control of his budget, even at the cost of stirring protest at home. He is confident of being able to

handle protest from below but not of braving the market as Mitterrand tried to do in 1981.

Hollande, like Sarkozy before him, is torn between broadly neoliberal measures (such as

reducing the tax wedge and amending labor laws in the direction of greater “flexicurity”) and

classical dirigiste measures (such as the French investment bank, state subsidies for industrial

research and development, etc.).1 Despite the liberalization of the capital account in the 1990s,

France has not really made up its mind about neoliberalism. Like a soccer team obsessively

guarding its own goal, French governments have made timid attempts to move the ball

downfield, only to retreat into a tight defensive formation at the first sign of trouble. Although

there are now more than ever good reasons to doubt the wisdom of neoliberal nostrums for

organizing the European economy, Hollande has to date been no more successful than other

social democrats at finding a workable formula for coordinating reflation across the continent

and assisting the troubled economies in the south while maintaining employment protection and

welfare-state benefits. There are no signs that his task will become easier any time soon.

1 I owe this formulation to Peter Hall. I want to thank Peter Hall, Peter Gourevitch, Alex Gourevitch, Robert

Kuttner, and George Ross for comments on an earlier draft.

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