Is France the Financial Time-Bomb of Europe?

As Greece, Spain, Portugal and Italy make difficult cuts in an attempt to make their economies more competitive, France is pushing back against austerity and in danger of becoming the socialist rump of Europe.

Fifty-seven percent of France’s GDP is government spending. Debt to GDP is now at 90 percent and climbing. France has high dividend taxes, very high payroll taxes, a wealth tax, a 35 hour work week and 10 percent unemployment. Add all this up and you have what The Economist magazine recently dubbed “the time-bomb at the heart of Europe.”

As if on cue, last Tuesday Moody’s credit rating agency downgraded French debt to onenotch below triple-A status. This followed a similar downgrade earlierin the year by S&P. Both agencies have a negative outlook forFrance, effectively a warning that further downgrades will come if structuralchanges to the economy are not made.

But structural change doesn’t come easy in France where a pampered, unionized workforce vocally resists any change to its unsustainable system. Simon Heffer writing in the Daily Mail recounts a few telling incidents which took place under former President Sarkozy:

Mr Sarkozy…commissioned a progressive socialist, Jacques Attali, todraw up a list of essential reforms that would make France morecompetitive and efficient. In January 2008, Mr Attali delivered a list of 316 proposals.The fate of two of these sensible suggestions symbolised the futility of the whole exercise.

First, take the example of Mr Attali’s idea that the number of licensed taxis should be increased. The number had remained the same since 1924. But taxi drivers, furious that more licenses would mean less work for each of them, called a strike which paralysed the city as other public transport services came out in sympathy. The idea was swiftly abandoned.

Second, reform of the way proprietary medicine was dispensed was proposed to break the monopoly enjoyed by pharmacists. Indeed, it is impossible to buy minor drugs such as aspirin in a supermarket in France. Thus Mr Attali proposed that any shop should be allowed to sell over-the-counter drugs. A strike by pharmacists put an end to that. 

The question is whether newly elected socialist President Francois Hollande can make the necessary changes to the French system despite being elected on a platform of reversing modest reforms enacted by President Sarkozy. Most notably, Sarkozy upped the retirement age in France’s equivalent of Social Security from 60 to 62, but Hollande ran on reversing this change. It’s a campaign promise he has kept.

In addition, Hollande has raisedtaxes on the wealthy to a top rate of 75 percent on incomes above onemillion Euros. His only significant cut has been a $25 billion reduction in corporate taxes, mostly offset by increases in personal taxes. This is estimated to cut labor costs by as much as 6 percent.

But all of the real work is still ahead of Hollande. France’s labor rules are notoriously stringent, making it difficult to fire anyone once hired. The 35 hour work week is another socialist initiative which may need to be put on the chopping block. Will Hollande be willing to stand up to the left wing of his own party to do it?

With the recent downgrade by Moody’s, the EU slipping into a double-dip recession and Hollande’s own poll numbers dropping like a stone, there are certainly plenty of market signals that something serious needs to be done and soon. But it remains surprising and counter-intuitive that France would elect a man who seems constitutionally averse to belt-tightening and then expect him to fix the mess. In that regard at least, France’s situation is not so different from ours here in the United States: a financial time-bomb entrusted to