France -- 2003 Article IV Consultation, Concluding Statement of the IMF Mission
June 30, 2003
1. We support the government's basic economic strategy, in particular the structural orientation of policies and the intention to resume fiscal adjustment. This strategy rightly recognizes that only far-reaching reforms can durably restore growth prospects and fiscal sustainability. Progress is being made on a broad front, accompanied by efforts to promote a wider public understanding of the need for reform. Most notably, a key and difficult milestone on the way to fiscal sustainability—pension reform—is being legislated. That such a commendable reform succeeded in a weak economic environment owes much to the foresight and tenacity of the authorities. The challenge now is to build on this achievement, continuing the reform effort to secure a similar success in the quest for overall expenditure restraint and create the conditions for higher potential growth—as persuasively argued in the introduction to the Débat d'orientation budgétaire 2003 (DOB).
2. Expectations of economic recovery have been repeatedly frustrated over the past two years and prospects for their realization remain uncertain. Indeed, the end of the Iraqi conflict failed to boost consumer and business confidence, with the latter instead continuing to slip. Soft employment conditions are taking their toll on consumption, the unclear outlook is holding back investment, and sluggish euro-area demand and the appreciation of the euro are weighing on the foreign sector. Nonetheless, excessive pessimism is unwarranted: considerable policy stimulus is in the pipeline, the effects of adverse shocks are waning, and the balance sheets of households, corporations, and financial institutions have held up comparatively well to the cyclical slowdown. As a result, we expect a gradual recovery beginning in the second half of this year, leading to growth of some 2 percent on average in 2004, after about 0.8 percent in 2003. Inflation is expected to decline to well below 2 percent in 2004 without indications that deflation is a risk in France at this point.
3. Macroeconomic policies will play a part in supporting the economic recovery. While monetary policy is the primary tool to address euro-area wide developments, domestic policies can also contribute. The full play being given to automatic fiscal stabilizers and the planned cuts in social security contributions related to the SMIC realignment are supportive factors. But it is also important to lift the various controls that are dampening the effects of ECB monetary easing in France. Thus, administered interest rates on regulated savings instruments should be lowered immediately, closing the wide margin vis-à-vis market rates. In a similar vein, it would be opportune to adjust or remove other interventions in financial relations that hamper the operation of credit markets (e.g., government-imposed fees that discourage mortgage refinancing and usury rates, see ¶ 12).
4. Budgetary policies must be decisively oriented toward achieving medium-term sustainability and raising potential growth. The aim should be to reach a small structural budget surplus within the next five years and run such a surplus for as long as needed to reduce the public debt-to-GDP ratio to deal with the costs of ageing and to create room for a desirable reduction in the tax burden. The confidence-enhancing aspects of such an approach could well have positive short-run effects on economic performance, especially if based on permanent expenditure reductions, while the related strengthening of the public finances would buttress the credibility of the common fiscal framework underpinning EMU.
5. The 2003 general government deficit is likely to exceed unambitious initial plans by more than 1 percentage point of GDP. This is a setback, especially to the extent that this outcome also reflects further slippage on expenditures, notably on health. At the central government level, all necessary measures must be taken to contain spending within the amount approved in the initial loi de finances. In this respect, we welcome the government's resolve to avoid the experience of 2002 when objectives announced in mid-year were not met. Regarding health care, a collectif social could have formally signaled the need to rein in social spending overruns. In its absence, savings measures should continue to be taken—as was done for drug reimbursements.
6. For 2004, we support the objective of reducing the underlying general government budget deficit by ½ of one percentage point of GDP by keeping central government spending constant in real terms and considerably slowing the growth rate of social security spending. To achieve the latter, specific measures on health care will need to be introduced already in the 2004 social security budget. We see no margin for reductions in the tax burden beyond what is already envisaged.
7. The credibility of the government's fiscal and economic policy strategy hinges crucially on its ability to reduce the share of public spending in GDP. Instruments available to date to control spending—such as the multiyear norms set out in Stability Programs and the ONDAM—have been ineffective. The new initiatives in this area—the conférences d'économies structurelles and the ongoing application of the loi organique—are thus highly welcome. Furthermore, following on the discussion of budgetary rules in the DOB, we see a strong case for adopting—if feasible starting with the 2004 budget—multiyear norms expressed in terms of the level of spending, in the context of a budget based on prudent growth assumptions, e.g., somewhat less than potential or medium-term average growth. Importantly, this framework should clarify that windfalls from growth exceeding potential would be saved, reducing the public debt. Nonetheless, it would leave room to allocate a margin should growth exceed the budget assumption. Such an approach would limit contentious debates on growth projections, enhance accountability, provide clarity on the level of resources available to spending agents, introduce a reference point to correct overruns, and secure consistency across successive budgets.
8. Reform efforts in the four priority areas identified by the government—pensions, health care, réforme de l'Etat, and decentralization—provide significant scope to reduce the expenditure-to-GDP ratio and illustrate the synergies between budgetary reform and possible increases in potential growth:
• Pension reform: aside from directly reducing the projected cost increases, the soon-to-be-phased-in changes in the contribution period and the system of discounts (décote) and premiums (surcote) stand to raise participation rates appreciably, thus boosting potential growth with positive feedback effects on fiscal sustainability. The formalization of five-yearly assessments of the system's prospects is highly welcome. These assessments should be used as an opportunity to further phase out differences among pension regimes, adjust key parameters to improve labor market performance, and verify whether the steep reduction in structural unemployment that is envisaged to free resources for the pension system is on track.
• Health care: if left unchecked, the rapidly rising health care costs risk undoing much of the fiscal sustainability gains from pension reform. France is certainly not alone in this plight, but in the absence of a blueprint for successful health care reform, it will be necessary to take continuous steps to curb spending growth. Measures adopted to reduce the overconsumption of drugs are welcome and should be pursued further. Pressures to raise fees of specialists need to be resisted or, should they materialize, offset by an effective increase in the co-payment (ticket modérateur), and the establishment of a referral system (médecin de référence). In addition, controls to avoid abuse of long-term sick leave need to be strengthened.
• Réforme de l'Etat: several initiatives in this area are welcome, e.g., the focus on performance within the public sector; the seeking of productivity gains through training, embracing information technology, and not fully replacing retiring civil servants; and the simplification of administrative procedures. We also encourage the ongoing reassessment of the confines of the role of the state.
• Decentralization: increasing the autonomy and accountability of local governments should over time provide scope to tailor services better to local preferences, reduce the cost of their delivery, and increase their quality. At the same time, the potential savings brought about by decentralization depend importantly on how it is implemented. The challenge is to provide the right incentives while maintaining fiscal discipline. The planned devolution of selected expenditure responsibilities is welcome, and will need to be accompanied by the granting of effective local fiscal autonomy. Sharing the proceeds of the TIPP may not meet this requirement fully, as only small variations in rates across regions would be possible. Some features of the current system that weaken local accountability (e.g., the assumption of part of local taxpayers' obligations by the central government) would need to be corrected. More generally, decentralization should provide an opportunity to streamline and avoid overlaps between the many levels of government.
9. No doubt, lowering France's onerous tax burden could raise potential growth but—as the government rightly emphasizes—it should be preceded by expenditure restraint. In addition, higher-than-projected growth should not be seen as providing room for more tax cuts, which would derail underlying adjustment. Nonetheless, there is scope to improve the tax system in a pro-growth direction. To reduce labor costs and strengthen work incentives, the tax structure could be rebalanced by decreasing social security contributions and raising broader-based taxes such as the VAT, the CSG, and environmental taxes. Reduced VAT rates on specific products or services should not be introduced, as such policies tend to misallocate resources rather than create net gains in output. On the contrary, the buoyancy and neutrality of the VAT should be improved by increasing the reduced rates to narrow the difference with the normal rate. Reduced rates are not an efficient way to achieve social objectives, as they benefit all taxpayers indiscriminately, including the wealthy.
10. Labor market performance has been adversely affected by the pursuit of equity and distributional objectives that has entailed an increase in labor costs, while measures to curtail the latter have been weighing on the budget. For example, alleviating the impact of the SMIC realignment is now absorbing much of the room available for tax reduction. The PPE addresses this tension since it avoids labor cost increases while redistributing income and enhancing work incentives, though it too has its budgetary cost. For their part, the jeunes en entreprise and RMA programs place a welcome emphasis on promoting employment in the business sector; on the other hand, any temptation to rekindle public employment programs for cyclical reasons should be resisted. The easing of workweek reduction requirements for smaller enterprises will prevent a further increase in labor costs while the suspension of some provisions of the loi de modernisation sociale should improve employment prospects. For both incentive and budgetary reasons, consideration should be given to restoring the dégressivité of unemployment benefits and introducing experience rating for employer unemployment contributions.
11. Product market functioning will be improved by the initiatives to reduce the regulatory burden, adjust the public procurement code, promote divestiture, and strengthen governance of public participations through the establishment of a new agency. Nonetheless, further divestiture of all commercial involvement should remain the primary objective and the practice of using proceeds from divestiture to recapitalize other enterprises should be phased out. In network industries, attention is rightly being directed to issues concerning the special pension regimes.
12. The performance of the banking sector has been favorable compared to previous economic downturns and the insurance sector has been weakened to a lesser extent than in other countries. Under the central scenario of a gradual recovery, risks should remain manageable. To improve the functioning of financial markets, administered interest rates should be reduced to market levels, and a transparent and simple mechanism put in place to prevent future misalignments. More generally, the system of administered savings is distortive and costly, and is in need of fundamental review. The objectives of promoting and protecting savings could be achieved more efficiently through other means, while social housing projects could best be financed through the issuance of long-term debt. Moreover, while we welcome the partial removal of the usury rate from the penal code, its relaxation or abolition would enhance the availability of credit. Finally, the interdictions on remunerating sight deposits and charging for checks should be lifted, in line with the approach of letting contracts (conventions) govern the relations between banks and clients.
13. An early adoption of the loi de sécurité financière will strengthen and simplify supervision, improve corporate governance and consumer protection, and clarify the authority for banking system competition policy. Given further consolidation in the banking sector, competitive conditions should be monitored closely. The ongoing efforts to improve cross-sector and cross-border coordination between supervisory and regulatory agencies are welcome.
14. The recent agreement on CAP reform and France's efforts to seek broad trade liberalization improve the chances of progress at the Cancún meeting. Still, many distortions remain, and we hope that these developments signal a decisive move away from the use of agricultural price supports and trade measures to achieve social and environmental objectives. France's contribution to development through its relatively high level of ODA and its intention to broadly double the current level of assistance to reach the UN target by 2012 are highly commendable.