France--2006 Article IV Consultation, Concluding Statement of the Mission
July 17, 2006
Describes the preliminary findings of IMF staff at the conclusion of certain missions (official staff visits, in most cases to member countries). Missions are undertaken as part of regular (usually annual) consultations under Article IV of the IMF's Articles of Agreement, in the context of a request to use IMF resources (borrow from the IMF), as part of discussions of staff monitored programs, and as part of other staff reviews of economic developments.
1. France has changed more during the past several years than is commonly perceived. Pension and health care reforms have improved long-term fiscal prospects and greater flexibility in labor and product markets has raised the economy's efficiency. Even so, further reforms are needed to allow France to significantly reduce unemployment, address population aging, and adapt the economy to fully benefit from globalization. To exploit synergies and balance the interests of various stakeholders, these reforms will need to cover several areas. Yet, prioritization is also necessary to ensure rapid progress. Priorities should include further fiscal adjustment through expenditure reduction, removal of judicial uncertainty surrounding labor contracts, widening of the differential between minimum and median wages, deregulation of the retail sector, and full disengagement of the state from commercial activities.
2. Reforms have been adopted successfully when they were well explained to the public and consensus was built among stakeholders. Pension and health care reforms and the strategy to lower the public debt burden are pertinent examples. Thus, the authorities' emphasis on raising public awareness of the need and benefits of structural reforms (pédagogie économique) is highly welcome. In particular, awareness should be raised regarding the impact of a high minimum wage on unemployment and public finances, the merits of shifting emphasis from protecting jobs to promoting job opportunities (la sécurisation des parcours professionnels), and the benefits of competition and product market reforms. The electoral calendar provides an opportunity to place these key economic issues at the centre of an informed public debate. It is also important to apply this pedagogic approach consistently. For example, "economic patriotism" may sound attractive, but it is misleading, since, in its protectionist interpretation, it runs counter to France's best interests.
3. Reforms have been implemented successfully when they were accompanied by clear objectives and supported by institutional arrangements. Public deficit targets and limits on central government and health care spending are relevant examples. The approaches in these areas rely on highly visible quantitative indicators monitored by institutions (e.g., the Comité d'alerte for the ONDAM in the health care sector, or the Conseil d'orientation des retraites, COR, for pensions). This approach should be extended elsewhere, for example to the family branch of social security and to local finances. It could also be adapted to structural reforms, for instance by focusing on employment rates for actions in the labor market (for the Conseil d'orientation pour l'emploi, COE), or product market regulation indicators for reforms in product markets.
4. The economic outlook is favorable. In the near term, the economy should continue to grow in line with the assumptions of the 2006 budget, and the unemployment rate is likely to decline further. There are a number of risks that appear broadly balanced: higher interest rates could slow asset price growth and euro appreciation could curb exports, while demand from trading partners could turn out stronger than expected. Despite recent improvements, export performance has been weak over the past three years, as reflected in declining market shares. This points to rigidities in the economy's supply response and the need for flexibility-enhancing structural reforms to allow it to benefit more from buoyant global growth. Such reforms would also be consistent with addressing another risk, that of a disorderly unwinding of global imbalances. For the medium term, prospects are for potential growth to remain at about 2 percent per year, higher than previously expected because of more favorable demographics and the effects of structural reforms. Nonetheless, this rate of growth would still imply an erosion of France's relative per capita income position.
5. Over the past three years, fiscal consolidation has progressed significantly. The general government deficit declined to less than 3 percent of GDP in 2005 and the 2006 objective of keeping it at no more than 2.8 percent of GDP is within reach. Underlying adjustment has been noteworthy, averaging about 0.5 percentage point of GDP per year during 2004-06. Together with further divestiture, this should permit a decline in the public debt burden in 2006, following a trend increase to 66.6 percent of GDP in 2005. The central government has observed its tight constant real spending targets for four consecutive years, thereby enhancing the credibility of fiscal policy. After years of overruns, health care spending was brought on track in 2005. Still, most of the consolidation was achieved through increases in tax revenues and social security contributions, and public expenditure has remained at historic highs, nearly 54 percent of GDP. Particularly worrisome is that the adjustment at the central level seems to have been largely undone by increased spending and hiring by the local authorities.
6. Against this background, medium-term fiscal consolidation and spending reduction goals are suitably ambitious, but achieving them will require bold measures. The agreement to reduce central government spending by 1 percent in real terms in 2007 constitutes a welcome breakthrough. However, given tax cuts and continuing spending growth outside the central government, medium-term consolidation is back-loaded, with little underlying adjustment in 2007. Hence, reaching budget balance by 2010 relies on adjustment of 0.8 percentage point of GDP per year from 2008 onward. A stronger adjustment in 2007 is desirable to attain a more evenly paced path and enhance the credibility of the authorities' approach. In addition, while the proposed medium-term spending norms for, respectively, the central government, social security, and local authorities are appropriate, the political choices needed to guide the achievement of these objectives remain to be articulated. These choices should involve increasing the rate of non-replacement of retiring civil servants at all levels of government (an opportunity that is being let slip by), halting the expansion of social programs, and moderating the increase in social benefits.
7. The considerable strengthening of fiscal governance achieved thus far should be extended to a number of areas. With the application of the organic budget laws for the central government and social security, a performance-based and medium-term oriented approach to budgeting and an ex-ante allocation of revenue windfalls have been put in place. The annual conference on public finances has begun to involve all the major actors in shaping fiscal policy, including, importantly, the local authorities. Further improvements should comprise a less frequent redefinition of spending responsibilities among segments of the public sector to enhance transparency and accountability, an injunction against introducing tax exemptions outside the annual budget law, the adoption of a budget pact between central and local authorities, and a strengthening of the capacity of independent institutions (e.g., Cour des Comptes) to contribute meaningfully to the public debate on fiscal policy.
8. Tax reforms have improved the economy's growth potential, but any additional reforms should be considered cautiously. The focus of tax reform on making work pay by reducing marginal income taxes and increasing the earned income tax credit (PPE), and on promoting investment, is highly welcome. Future reforms should, however, be funded by additional expenditure restraint to preserve a steady pace of underlying fiscal adjustment. In this context, the increasing recourse to tax expenditure needs to be halted to avoid eroding the benefits of improved spending discipline. While the concern to fund social security not just from taxes on labor is legitimate, the current proposals to shift taxation will have negligible economic effects, and labor is likely to continue to bear the incidence of taxation.
9. The labor market has become more flexible but the employment effects are still limited and the budget remains heavily burdened by measures taken to safeguard jobs in the face of ongoing real increases in the minimum wage (SMIC) and social benefits. The authorities' strategy, focused on gradual changes to existing labor market institutions and improvements in the efficiency of government-supported programs, has yielded some gains. The loosening of the 35-hour workweek restrictions and the reform of collective bargaining have increased the flexibility of working hours. The new labor contract (CNE) has facilitated hiring by small enterprises. Employment services have been improved, and the pension reform and measures proposed for older workers are likely to increase their participation rate. However, tax incentives, cuts in social security contributions, and renewed recourse to subsidized employment schemes continue to pressure the budget. The secular rise of the SMIC has compressed wages at the bottom end, limiting prospects of wage progression. In sum, the approach to labor market problems has remained partial, which is likely to disappoint in terms of overall results and perpetuate the division of the labor market into a highly protected and a highly precarious segment.
10. In this context, a socially acceptable and economically effective recipe for putting more people into jobs will have to include several ingredients. The judicial uncertainty linked to permanent labor contracts should be removed. This will spur hiring, establish more secure job prospects, and permit both firms and workers to benefit from globalization rather than having to fear it. The wedge between the SMIC and the median wage needs to be increased so that people who progress in their career can benefit from their efforts. Similarly, the gap between revenues from inactivity and the SMIC needs to be widened to better reward the return to work. Resulting budgetary savings could be allocated to a rise in the earned income tax credit (PPE), which would help the low skilled find jobs without increasing their risk of becoming poor.
11. Strengthening ongoing product and services markets reform could appreciably boost potential output and consumer welfare, lending support for reform in general. As observed with the reform of the distribution sector and the action of the competition authority in the case of telecoms, consumers stand to benefit considerably from increased competition. Continued withdrawal of the state from commercial activities and more emphasis on consumer rights are helpful initiatives. In this context, liberalizing shop opening hours and sales periods, and shortening and simplifying administrative procedures, especially for start-ups, would have large benefits, as would the swift liberalization of the services market in the EU context. Successful implementation of the initiative to promote research and development, which will require limiting bureaucracy and fully involving small and medium-scale enterprises, stands to improve productivity. It will, however, be important to prevent any wasteful allocation of public resources. As the country moves towards the technology frontier, improving education will become increasingly important. Given the long gestation time of changes in education, starting them soon will be essential.
12. The financial sector remains well capitalized and highly profitable, placing it in a good position to manage increasing risks. A substantial part of the recent rise in profits is likely to be transitory, however, as it is linked to the reintegration of past provisions, low current provisioning, and rapid credit growth. Going forward, risks include a relaxation of loan standards in the face of sharp competition for market share, rising exposures to real estate, emerging markets, and high-leverage credit products, and a possible disorderly unwinding of global imbalances. As recognized, supervisors need to remain on top of these issues.
13. By improving its efficiency, the financial sector could contribute more to growth and stability. Phasing out administrative savings schemes, for example by allowing all rates to be fully market determined and reducing fiscal advantages (as done in the case of the PEL savings), should increase competition for resources. In turn, this should foster financial innovation and the development of risk capital markets, crucial for the growth of small, innovative firms. Further reform of the mortgage market beyond the current welcome initiative seems necessary to permit efficient and flexible use of housing collateral. The Postal Bank should be allowed to develop into a full-fledged bank and be privatized. Complete integration of Europe's financial markets will be a boon for growth. It will require faster progress by France and all other member countries in establishing standardized financial products, documentation and underwriting practices, integrating trading infrastructure, and harmonizing legal, tax, and prudential frameworks.