France -- 2007 Article IV Consultation, Concluding Statement of the IMF Mission
November 19, 2007
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 is on the move. The election of a new president and government on a declaredly reformist platform provides an historic opportunity to place France onto a sustained growth path with greater opportunities for all. An unwavering drive for reforms, entailing a true rupture from the past, and complemented by a stronger fiscal adjustment than currently planned, would create a virtuous cycle of higher growth, healthier public finances, and lower unemployment.
2. The government's reform approach and priorities are well-placed. In the debate on the optimal sequencing of reforms, we believe it is appropriate to aim for a "critical mass" of simultaneous reforms across a wide range of areas, thereby exploiting the synergies of contemporaneous action and—by addressing rents across several markets—more fairly distributing costs and benefits. Fund staff simulations show that such a strategy would yield appreciably larger and faster growth dividends than a gradual and piecemeal approach. Action also needs to be rapid. "All the reforms at the same time" is however not a practical policymaking guide: to the extent that choices must be made, efforts are best concentrated where current market distortions are the greatest—disincentives to work and mobility in the labor market and a host of constraints on competition in services markets—as is indeed being planned. In implementing such a wide-ranging effort, an inter-ministerial coordination mechanism to prioritize and monitor progress would be helpful.
3. Economic policy needs to address the root cause of France's growth deficit: the weakness of its supply potential. There is a widespread public perception that a lack of purchasing power (pouvoir d'achat) is constraining growth. While there are appreciable income distribution issues, the root causes of France's growth difficulties do not lie in deficient consumer demand. France has enjoyed a substantial rise in real disposable income relative to its euro area partners since 2000, but this injection served to widen the country's growth deficit, as consumption and domestic demand outstripped supply, sapping output growth via imports. A key weakness in France's recent macroeconomic performance has indeed been in the external sector, where performance has slipped, both compared to the country's own past and to euro area partners, reflecting weakening competitiveness, but also broader supply rigidities. The government's reform agenda rightly aims to address the latter, but its concomitant emphasis on raising purchasing power—while understandable in political economy terms—blurs the problem and raises unrealistic expectations. Gaining the percentage point of growth that France is missing requires an unambiguous focus on the country's supply deficiencies. Such a focus would better advance the government's broader pédagogie économique effort, imparting an overarching internal coherence to its economic strategy.
4. The economic outlook points to a continuation of recent performance, but is clouded by risks from the global environment. GDP growth for 2007 is likely to remain marginally under 2 percent, sustained by strong domestic demand while net exports continue to disappoint. In contrast with the rest of Europe, growth is expected to accelerate slightly in 2008, reflecting the demand stimulus of last summer's fiscal measures (TEPA), but to remain unbalanced between domestic and external sectors. The economy has handled the recent financial turbulence well, though the effects of the global turmoil continue to unfold. The external environment contains other significant downside risks: a stronger than expected slowdown in the U.S. and Europe, higher energy and commodity prices, and a further strengthening of the euro. Headline inflation has picked up, driven by sharp increases in oil and commodities prices, but underlying inflationary pressures appear muted.
The reform agenda—freeing the labor market
5. With one of the lowest labor inputs in the OECD, France indisputably needs to "work more" if it is to "earn more." The government's emphasis on work effort is most apposite for a country with appreciably lower than average labor force participation, employment rates, and annual hours worked. The ills of France's labor market—possibly the greatest barrier to higher growth—are well-known. They were effectively summarized in the president's speech to the Journalistes de l'Information Sociale last September, from which we would highlight three main areas.
6. Improving labor market performance requires a fundamental change in the evolution of the minimum wage (SMIC). The secular rise of the SMIC has priced young and unskilled workers out of market jobs; compressed wages at the bottom end and demotivated effort; and weighed heavily on the public purse as cuts in social security contributions attempted to offset these adverse effects. Hence, the decision to forego this year any coupe de pouce is welcome and should be perpetuated. The current reflection on the modalities of adjusting the SMIC should result in a system that widens the wedge between the SMIC and the median wage, to reward career progression, and between revenues from inactivity and the SMIC, to encourage the return to work. The establishment of a "low pay commission" of independent experts to advise on the yearly setting of the SMIC, as well as to raise awareness of the impact of a high minimum wage on unemployment and public finances, would be helpful. In this context, the planned review of social benefits (minima sociaux), and the experimentation with the Revenu de Solidarité Active, should lead to a consolidation of the system and improve incentives for participation in the workforce.
7. The ongoing negotiations on the modernization of the labor market should also seek agreement on changing the present, highly limiting juridical framework. We are concerned that these negotiations appear instead to be taking the present legal framework largely as given, constraining the possible reforms to labor contracts. A true rupture from the past and a genuine improvement in the working of the labor market will require amending the current legal provisions for licenciement économique, so as to facilitate workforce adjustment without costly recourse to individual dismissals. The judicial role in labor relations should be reduced so as to allow for faster and less uncertain outcomes. Separating the cause of layoff from the provision of unemployment benefits would also be important.
8. Effective employment services are key to improved labor market performance, and the planned merger of ANPE and UNEDIC will need to be carefully managed to ensure success. We welcome the renewed emphasis on moving the unemployed back to work via closer and unified guidance of job-seekers. But experience, both in France (with the PARE) and internationally, demonstrates that the practical success of such approaches rests on the interplay of effective financial incentives to seek work (e.g., via a tapering of unemployment benefits—degressivité) with strict enforcement of the conditionality of benefits, within a system of clear rights and obligations of job-seekers.
The reform agenda—raising competition and consumer welfare
9. Further goods and services market reforms could significantly boost potential output, competitiveness, and consumer welfare. The guiding principle here must be to promote competition throughout the economy, along two main avenues.
10. Moving competition policy to center stage would be aided by a unified, independent, and reinforced competition authority. We welcome the emphasis placed on competition, as highlighted in a special chapter of the Rapport Économique, Social et Financier. Making this emphasis operational in our view requires a change in the institutional framework, modifying France's dualistic setup (the Conseil de la Concurrence and the DGCCRF at the Ministry of Economy and Finance), and in particular removing responsibility for merger control from the ministry—an arrangement at odds with international best practice. We fully support the Attali Commission's proposal to merge these entities into a reinforced, independent competition authority, which we would vest also with a mandate to be a public advocate for competition and a watchdog against rent-seeking behavior in the country. With respect to merger control, while final decisions tend in many countries to reside in the governmental sphere, the process should be transparent, based on the competition authority's opinion, and with the requirement that any divergent ministerial decision be motivated. For cross-border competition issues, the strengths of the present EU arrangements—vital to the workings of the internal market—should be fully safeguarded.
11. Early action to reform some key services markets (notably distribution) can pave the way for implementation of the EU Services Directive—a liberalizing opportunity that should be fully seized. We welcome the preparatory work being done for the implementation of the Services Directive, with a careful review of all regulations. In this process, the degrees of freedom allowed under the Directive should be used with the utmost parsimony, fully suppressing entry barriers and anti-competitive regulations in all services. But action need not await the Directive's drawn-out timetable, and can proceed forthwith in several areas—as indeed is the government's intention, most notably as regards the plethora of regulations in the retail distribution sector. Steps taken earlier have already yielded results on price formation, to the manifest benefit of the consumer, and more are being planned. Here, too, we would agree with the Attali Commission's recommendation to do away with the prohibition of below-cost pricing (revente à perte) and allow full contractual freedom. Repressing the abuse of market dominance and predatory pricing is the task of general competition law under a reinforced competition authority, not of tortuous provisions that attempt to micro-manage producer-retailer relations. Easing regulations on zoning, retail opening hours, and sales periods all go in the same desirable direction and should be enacted promptly.
The reform agenda—improving expenditure and tax policies
12. An essential component of France's reforms must be a break with the tendency to address economic difficulties via the public purse. This long-standing approach has caused a dysfunctional environment where one economic distortion is addressed by spending and tax concessions that often introduce additional market distortions and, in any event, weigh on the public finances. As a result, both public spending and taxes have remained at stubbornly high levels relative to GDP. In this context, the general reviews of public spending (RGPP) and of tax policy (RGPO) are most welcome, standing to yield appreciable results over time. While awaiting the outcome of these exercises, it would be useful for the government to declare a moratorium on all new tax expenditures and resist addressing current challenges (such as high oil prices) with tax concessions.
13. The planned general review of public expenditure (RGPP) is an important initiative to secure lasting expenditure reduction. Commendable efforts have been made in recent years to improve fiscal governance and control expenditures, notably via the Organic Budget Law (LOLF) and related performance audits. The broader review being planned will allow going beyond rationalizing costs and raising efficiency at the margin, so as to achieve a more fundamental and lasting improvement, reducing public spending—and hence over time the level of taxation—as a share of GDP. Among the key elements of the review should be a sharp reduction in tax expenditures and the enshrining of the principle that all such tax decisions be taken only in the context of the Loi des Finances. A review of the extensive role of the state in the economy is also key and should, as planned, include a rationalization of the overlapping functions of multiple levels of local governments—a process that should have accompanied decentralization. The planned merger of the tax and public accounting directorates (DGI and DGCP), a welcome modernization of the structure of tax administration, is also a positive example of rationalization of the state's presence. Finally, progress with the RGPP will place public spending in a strategic framework, key to moving toward multiyear budgeting.
14. Similarly, the general review of the tax system (RGPO) is timely and welcome. While there have been important improvements to the tax and benefit system in recent years, a succession of piecemeal reforms has resulted in a system that is complex and marked by significant distortions. The RGPO should allow the authorities to reevaluate, in light of tax reforms adopted elsewhere in Europe, the type of tax system needed to address the challenges of the globalized economy of the twenty-first century. The tax reform should be designed with a view toward a simpler system with fewer distortions. There are several areas for reform of the main taxes:
• The statutory rate of the corporate income tax (IS) will soon be the highest in Europe. A reduced rate, combined with a broader base, could make the system simpler and fairer, and may deter the shifting of profits and investment to lower-taxed countries.
• We would recommend further simplification of personal income taxes. The restructuring of minima sociaux via the RSA could help eliminate the distortions implied by the complexities of the tax-benefit system. Moving to withholding of the personal income tax should also be taken forward—other countries have dealt with the related transition problems successfully.
• The VAT in France is increasingly out-of-step with best practices around the world. A move to unify VAT rates and broaden coverage would potentially raise as much revenue or more with a headline rate much below the current 19.6 percent, reducing incentives to informality and allowing distributional objectives to be pursued by better-targeted instruments.
• We welcome the emphasis to be placed on environmental issues in reviewing the tax system, with France intent on taking a leadership role in addressing climate change.
15. Both the expenditure and tax policy reviews stand to provide lasting improvements in the fiscal position, but with full effects only over the medium term. Any expectations of early results should be tempered. In 2008 and 2009, fiscal consolidation will have to be based on tight spending plans and the recognition that the present state of public finances allows no scope for further tax reductions—a basic tenet of the Péberau Report on France's public debt.
Fiscal policy—strengthening the adjustment effort
16. While the 2008 budget contains several commendable initiatives, it implies an inopportune pause in fiscal adjustment, stemming from the TEPA provisions. The 2008 budget incorporates an unprecedented reduction in public employment; improves the coverage of the central government expenditure norm; increases the precautionary reserve; limits the growth of state transfers to local authorities; and contains further measures to enhance the co-responsibility of health care users and discourage early retirement—all positive features. But the resulting expenditure restraint is largely offset by the TEPA provisions. We fully appreciate the signaling intent of the package: to extol work effort, impart greater confidence, and keep electoral pledges—key to the success of the reform agenda. But, from a technical and economic viewpoint, the TEPA appears as a less-than-optimal response to the country's underlying economic problems. Notwithstanding some positive features, such as the reformed R&D tax credit, the provision's largest effects are on the demand side. International experience shows partial tax credits for mortgage interest to be problematic, with little impact on home ownership or economic growth. Indeed, France removed such a measure about a decade ago. While the aim of reducing workweek restrictions, providing enterprises with greater flexibility and lowering marginal wage costs, is laudable, the exemption of taxation on overtime entails considerable windfall effects (effets d'aubaine), is operationally complex in order to avoid likely fraud, and benefits insiders. Given its cost in terms of lost revenue, its effect in increasing working hours, which is subject to uncertainty, will have to be monitored carefully. The measure is overall a second-best response to the original distortion of the mandatory workweek reduction. It is emblematic of the pernicious nexus between rigid labor market institutions and the budget that, after having spent considerable sums to implement the 35-hour workweek, additional public money is now being diverted to circumvent it.
17. Implementation of the 2008 budget should be attentive to risks of slippage. These risks stem primarily from the prospect of lower-than-budgeted growth and from continued spending pressures, most notably in social security (both health and pensions). If the global downside risks to growth were to materialize, the deficit could move perilously toward its Maastricht limit. Public policy should be vigilant to these risks, intervening with corrective action in the course of the year as needed.
18. Fiscal consolidation and structural reforms should be seen as complementary, and—given the distance separating France from its medium-term fiscal objective—it should adjust by at least ½ percentage point of GDP per annum. Fiscal consolidation based on durable expenditure cuts is an essential component of the strategy to boost economic growth, increasing the scope for sustainable tax relief and creating economic space for private sector growth. Debt and deficit reduction should remain a national priority as enshrined in last year's budget documents. Placing fiscal adjustment back on track would promote credibility—eroded by the continued postponement of the medium-term objective—and begin to create a cushion against future shocks and population aging. It will require a return to stricter spending targets for the central government; implementation of pension reform in 2008, including notably the extension of the contribution period (here, the government's current firmness on a similar extension for the special regimes is crucial); further healthcare reforms to expand co-payments and reduce underlying spending pressures; and strengthened commitments to restrain local government spending. The practice of a comité d'alerte for healthcare has functioned well and could usefully be extended to other areas. Finally, we would caution about the potential spending pressures that could arise from the intended creation of a fifth social protection pillar (dependency), where private insurance mechanisms should play the primary role.
Financial sector—heightening its growth contribution
19. The French financial system has weathered the recent world financial market turbulence well. The system's strong capitalization, its modest exposure to the U.S. subprime mortgage market, and a supervisory system that covers all credit-granting institutions have all contributed to this relative resilience. Still, the current environment continues to pose challenges, as market conditions have yet to return to normal, which could further increase banks' financing costs, reduce their profitability, and induce credit tightening. There also may be contagion risks to other markets, such as structured credit and LBO debt. Continued vigilance will thus be paramount. Within France, marketing practices of "dynamic" money market funds may need to be reviewed. In other areas, we welcome the authorities' readiness to include a European dimension in the statutes of national regulators and the impulse they intend to give to the Lamfalussy process ahead of France's EU Presidency in the second half of 2008.
20. The "Paris-Place Financière" initiative provides an important opportunity to further modernize France's financial markets. France's financial system, while a leader in some sectors (notably equity derivatives and asset management), continues to carry the legacy of a heavily regulated and administered past. The contribution that a modernized financial sector can make as a driver of economic growth deserves greater prominence. To improve the efficiency of the banking sector, administered loan and savings schemes should be phased out and the state's role in the financial sector reduced. The ending of the monopoly on the distribution of Livret A would provide opportunities in this direction; in particular, with the Banque Postale being given the possibility to become a full-fledged bank and in due course privatized. The planned review of the governance of the Caisse des Depôts is also a positive step.