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France: 2001 Article IV Consultation
Concluding Statement of the Mission
July 11, 2001
1. France has enjoyed impressive rates of growth with low inflation in recent years, sustained by the virtuous interaction of sound macroeconomic policies and a favorable economic environment. In particular, several years of gradual structural reforms have significantly improved labor market performance, contributing to the unprecedented job-richness of growth. At the same time, taxes have been reduced, while the fiscal deficit has narrowed. No doubt, the economy is now structurally sounder. Part of the positive results are however also cyclical in nature, and several structural indicators remain comparatively weak. Labor force participation is low, unemployment is still high, the tax burden remains heavy, and the structural fiscal balance has not improved appreciably in recent years.
2. Since the end of last year, a deterioration of the external environment has slowed economic growth and prospects have become appreciably more uncertain, though they remain broadly positive. Barring further adverse shocks, we expect the pace of economic expansion to slow to 2.3 percent in 2001, before returning toward its potential rate next year. This forecast hinges on the continuing strength of consumer spending, based on robust growth in household disposable income. The main risk lies in a further weakening of external demand that could dampen job creation, halt the decline in unemployment and, consequently, restrain consumption. Inflation is expected to decrease gradually during the second half of the year-as pressures from recent energy and food price increases unwind-and remain well below the euro-area average. Together with the economic slowdown, falling inflation should be conducive to a continuation of wage moderation. But there are some risks in this regard: wage claims could be boosted by the recent uptick in inflation and by the sizeable increase in the SMIC (largely driven by the perverse working of the indexation mechanism in the context of the 35-hour workweek). With the renegotiation of the first wave of the 35-hour contracts, and the implementation of the workweek reduction for smaller firms, labor cost pressures could emerge looking forward.
3. The anticipated slowing of the economy is not of a magnitude or nature to warrant short-term activism, neither on the fiscal front, nor with respect to labor market policies. Rather, the medium-term orientation of budgetary and structural policies should be strengthened, and the policy focus placed resolutely on the long-term challenge of raising the economy's growth potential, especially by expanding labor supply. In this vein, calls from some quarters to reverse the multi-year tax reduction plan in favor of greater expenditure or to expand subsidized employment programs, as well as steps that go against the grain of recent labor market reforms (such as certain provisions of the draft loi de modernisation sociale), are misplaced.
4. Consistent with this orientation, current cyclical risks can be adequately addressed by a balanced policy mix that should comprise supportive monetary conditions and, on the fiscal side, the operation of automatic stabilizers on revenues. Allowing these stabilizers to play, while holding strictly to the targeted expenditure path in 2001 (which, in current circumstances, calls for corrective action due to overruns on health spending), entails a stance of fiscal policy that is sufficiently supportive for the French economy in the near term. Consequently, the likely cyclical widening of the actual budget deficit compared to current plans-possibly already in 2001, but, owing to lags in tax collection, more probably in 2002-should not in itself be a cause for concern.
5. With cyclical risks thus contained, but a structural fiscal position that is essentially unchanged since the start of EMU, France must now set itself the objective of decisive fiscal consolidation in order to address its long-term demographic pressures. In this light, we view rapid progress toward structural fiscal balance, paving the way for a sustained long-term decline in the debt-to-GDP ratio, as paramount. Translating this approach into medium-term requirements, we indicated last year that it would be both desirable and feasible to achieve this objective by 2003, and continue to believe so. Since then, the latest Stability Program implies a target of structural fiscal balance by 2004. This difference in timing is not per se economically significant: what is however of crucial importance is that this objective be made explicit and not moved further into the future.
6. To achieve this objective, several sources of budgetary pressure will need to be carefully managed. First, cuts in taxes and social contributions risk outpacing expenditure restraint. At the same time, it is unclear to what extent the recent buoyancy of revenues is a structural phenomenon, and consequently, what the likely medium-term impact will be of the ongoing tax reduction. Second, expenditure control in the health care sector continues to be elusive, and will be further challenged by the introduction of the 35-hour workweek in public hospitals next year. Third, various initiatives-notably with respect to the labor market and social assistance-will place additional pressures on outlays (e.g., the extension of the emplois jeunes program, the introduction of the allocation personnalisée d'autonomie, and the changes in the unemployment insurance scheme). The response to some of these expenditure pressures has included an upward revision of multi-year norms for real expenditure growth between the 2001-2003 and 2002-2004 Stability Programs. Apart from delaying consolidation, such a response also risks undermining the credibility of the fiscal policy framework.
7. These considerations argue for a further strengthening of France's fiscal framework, building on recent progress. First, the multi-year expenditure norm should be presented with the annual budget document to better integrate it within the budget process and strengthen the commitment. Second, this norm needs to be complemented by an explicit longer-term domestic objective for the structural fiscal balance or the public debt. In this sense, we welcome the emphasis on "preparing for the future" in the recent Rapport pour le débat d'orientation budgétaire, and its focus on a long-term target for the public debt-to-GDP ratio in view of demographic pressures. Third, to guard against base drift (as happened in 1999) and facilitate monitoring of compliance, the expenditure norm should be set on the level of expenditure rather than its growth rate. Fourth, a clear and transparent mechanism to correct deviations should also be put in place, and target revisions in mid-course avoided. Finally, to be effective, the norm should continue to encompass all general government expenditure. Its implementation will require a clarification of the respective roles and commitments of the central government, local authorities, and social security funds in contributing to expenditure restraint.
8. On the structural front, a reinvigoration of reform efforts is crucial-in France as elsewhere in Europe-to bolster the economy's resistance to shocks and raise its growth potential. France's record on structural reforms shows, on the one hand, appreciable progress in improving labor market performance, lowering the tax burden and, prospectively, changing incentives in the civil service (most notably through the application of the new loi organique). In contrast, substantive pension and health care reforms remain on hold, and-other than in telecommunications-enhanced competition in key network industries continues to encounter resistance.
9. In the labor market, significant strides have been made in promoting employment growth. Measures so far have focused mainly on raising the demand for labor, essentially by lowering social security contributions and through a number of subsidized employment programs. Under full implementation of these measures, the burden on the budget will be sizeable, and possibly difficult to sustain over time. In new initiatives, priority should be given to increasing labor supply, in particular by reviewing the benefit system so as to make work rewarding and alleviate inactivity traps. Recently, reforms to taxes and benefits have indeed moved in this direction-most notably with the introduction of the prime pour l'emploi (PPE). In addressing the interaction of taxes and benefits to sharpen incentives to move into work, one avenue to consider would be to phase out some benefits while increasing the PPE.
10. In the period ahead, the labor market will be marked by two major initiatives: the further implementation of the reduction in the workweek, and the reform of the unemployment insurance system. We welcome the recognition that the extension of the 35-hour workweek to smaller enterprises will need to be implemented in a flexible manner and, in particular, we remain convinced that there is scope to lift restrictions on overtime limits. Looking forward, a worrisome aspect of the reduction in working time is the issue of multiple SMICs and income guarantees, and the accompanying commitment to align these different minimum income levels by 2005. In any decision in this regard, the overriding consideration should be to avoid significant increases in labor costs that would undermine France's hard-won competitiveness gains, achieved over many years of wage moderation. On the unemployment insurance system, we support its renewed emphasis on helping the unemployed to return to work. However, it will be important to ensure that the PARE and PAP programs are effective at an acceptable fiscal cost. In light of the elimination of a financial incentive to seek work (the degressivité), maintaining effective conditionality of benefits will be crucial.
11. In the civil service, the shift in emphasis from a means- to a results-oriented system that is already being implemented in some areas, and the new organic budget law are most welcome and potentially far-reaching innovations. The introduction of the 35-hour workweek and the anticipated wave of retirements should provide an opportunity for reorganization and rationalization. This process should proceed in tandem with the preparation for the implementation of the organic budget law which, while taking full effect only in 2005, can already serve to alter incentives in the civil service.
12. The need for pension reform is now well established, and awareness is growing of its interaction with labor market performance through its impact on participation rates of older workers. The presentation of various scenarios by the Conseil d'orientation des retraites has clearly highlighted the importance of the policy reforms that are needed to further lower unemployment, and to raise participation and productivity-key parameters for the evolution of the pension burden. The problem has been amply analyzed, and substantive reform should be undertaken without further delay. Reforms should eliminate remaining disincentives to participate in the labor force and differences between the public and the private sectors, reduce intergenerational inequities, and allow the individual a fair choice between work and retirement. The introduction of individual savings plans (PPESV) is one aspect of this choice, while lengthening contribution periods and reducing the public debt are needed to address the fiscal dimension of the pension problem.
13. The health care system will continue to cause financial pressures that will need to entail a more realistic approach to expenditure budgeting in the sector. In addition, it will be essential to raise the effectiveness of control mechanisms on health care providers, and to introduce adequate microeconomic incentives to raise cost awareness. The recent plan regarding prescriptions (plan médicaments) is a good start.
14. We welcome the emphasis being placed by the authorities on increasing competition and, more generally, enhancing the attractiveness of France to investors and entrepreneurs. Underlying this approach is the recognition of the important contribution that openness, competition, and liberalization can make to enhancing the supply-side potential of the economy. This recognition should now be decisively applied also to network industries and services.
15. The financial sector continues to evolve rapidly and financial institutions have benefited from the cyclical upswing. To keep pace with developments, it will be necessary to enhance seamless cooperation between supervisory agents across sectors and across borders, and we look forward to the passage of the financial authority reform bill. At the European level, we welcome France's leading role in fostering the integration of EU financial services, inter alia through the establishment of Euronext and its support to the Financial Services Action Plan. In this context, the planned extension of the coverage of the equity savings plan (PEA) from French to European companies is a further positive step. In order to enhance financial sector efficiency, we would also encourage the authorities to remove various anachronisms: the prohibition of remuneration of sight deposits; the requirement to provide checks free of charge; and the system of administered interest rates. In the same vein, we see the ongoing process of financial consolidation as providing an opportunity for creating a level playing field, and for the State to eventually withdraw from the banking system.