France: 2012 Article IV Consultation--Concluding Statement
November 5, 2012
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.
The growth outlook for France remains fragile reflecting weak conditions in Europe generally, but the ability of the French economy to rebound is also undermined by a competitiveness problem. As financial stability risks abate, and with the prospects of a gradual resolution of the euro area crisis, France’s competitiveness gap emerges as the main challenge for macroeconomic stability, growth, and job creation. The government has rightfully launched a broad debate on the subject and has engaged social partners in a dialogue on critical reforms. This creates a unique opportunity to achieve meaningful reforms. The government has also demonstrated strong fiscal resolve, which has helped anchor market confidence. Going forward, policy priorities should be: (i) quality fiscal adjustment, based on a stronger containment and rationalization of public spending to improve its efficiency and to create room for a reduction of the tax burden over the medium term; (ii) reforms of the labor market and services to reduce costs, increase the capacity of enterprises to invest and adapt, and create more efficient and inclusive outcomes in terms of growth and employment; and (iii) a rationalization of the taxation of financial income to ensure an adequate flow of long-term (including equity) financing to enterprises.
1. Reflecting persistent weakness in the outlook for Europe, the mission projects that real GDP growth in France will accelerate only marginally in 2013, to 0.4 percent from 0.1 percent in 2012. While market tensions have recently eased, the path towards a resolution of the euro area crisis remains uncertain, and fiscal consolidation throughout Europe (aimed at repairing public balance sheets and improve confidence) will continue to depress demand in the area. In this environment, job creation will remain subdued and, despite the measures planned by the government to improve job prospects for new entrants and seniors, the unemployment rate could increase further.
2. The growth outlook for France is also clouded by a significant loss of competitiveness relative to its trading partners. This competitiveness gap is reflected not only in a deteriorating export performance, but also in the low profit margins of enterprises, which constrain their capacity to invest, innovate and create jobs. The loss of competitiveness predates the crisis, but risks becoming even more severe if the French economy does not adapt along with its major trading partners in Europe, notably Italy and Spain which, following Germany, are now engaged in deep reforms of their labor markets and services sectors.
3. Against this background, the economic policy challenges are on three main fronts:
• Sustaining fiscal consolidation over the medium term to decrease the burden of debt; but at the same time focusing on quality fiscal adjustment in order to strengthen incentives to work and invest.
• Correcting labor market impediments to investment, employment, and ultimately growth, and extracting more value out of the services sector through greater competition.
• Consolidating the significant progress already achieved in terms of financial stability, while ensuring that savings are effectively intermediated to the economy, as banks and insurance companies adapt to new prudential requirements.
Quality fiscal adjustment
4. The government’s demonstrated commitment to ambitious fiscal deficit targets for 2013 and the medium term strengthens policy credibility, which over time had suffered from the persistence of large structural deficits. The gain in credibility is confirmed by the marked decline in interest rate spreads vis-à-vis Germany, which also reflects a broader easing of euro area tensions. While front-loaded fiscal adjustment provides a strong signal of the government’s resolve, it may, however, dampen an already uncertain short-term growth outlook. A pickup of growth in 2013 along the lines expected by the government should permit the measures deployed in the draft 2013 budget to achieve the government’s fiscal target. By contrast, persistent weakness of economic activity in the euro area (and in France) should be the occasion for France, its European partners, and European institutions to review jointly the speed of fiscal consolidation at the European level, with a view to providing more support to the recovery.
5. The quality of fiscal adjustment would be enhanced by a rebalancing of the fiscal effort toward expenditure containment beyond what is currently envisaged. With rates of taxation (and government spending) already among the highest in Europe, the ratcheting up of the tax burden in 2012-13 further undermines incentives to work and invest, and places France at an additional competitive disadvantage relative to its peers. A more ambitious objective of expenditure containment over the medium term, relative to the current multi-year plan, appears warranted to enable a gradual reduction of the tax burden, to levels closer to those of European partners. Given the relatively optimistic growth assumptions on which the medium-term framework is built, tighter expenditure targets are also desirable to protect the deficit objective against the risks of less favorable growth outcomes.
6. Expenditure containment should involve all levels of government, based on a rationalization of spending. In this regard, the initiatives taken by the government to improve the efficiency of public spending are particularly welcome, notably with the Modernisation de l’Action Publique (Initiative to Modernize the Role of Government) and stricter ex-ante evaluation of public investment projects. These actions will need to be accompanied by: a better match between resources and mandates across the various levels of government as part of the Acte III de la Décentralisation (third phase of decentralization); strict containment of health spending (ONDAM); and tighter controls over the wage bill of all government institutions. The government’s decision to review periodically the efficiency and the rationale of tax expenditures and social security contributions exemptions is also welcome, especially if it is used to achieve a more efficient tax system based on a broader base and lower rates. France has undertaken an important reform of pensions to place the system on a more secure financial footing. This reform also appears to have increased the participation of seniors in the labor market, with a positive impact on potential growth. Consistent with these achievements, any revisions to the pension system needed to maintain its financial balance should continue to rest on an increase in the retirement age rather than an increase in contributions.
7. The organic law transposing into French law the Fiscal Compact also contributes to the enhanced credibility of French fiscal policy. Through its built-in fiscal rule and corrective mechanism, the organic law will anchor annual budgetary policies more firmly into a medium-term objective of budgetary balance. Under the new architecture, the Haut Conseil des Finances Publiques (HCFP, High Council of Public Finances) will play an important role by providing an independent view on the appropriateness of the macroeconomic projections that underpin the budget and by monitoring the implementation of corrective actions in the event of deviations from the established fiscal trajectory. As established, the HCFP offers strong assurances of independence. It will be important to avoid possible conflicts of interests between the monitoring and ex-ante evaluation roles of the HCFP and the ex-post audit and advisory role of the Cour des Comptes (Audit Court) to which the HCFP is associated, notably in terms of corrective budgetary actions to be taken in the event of deviations from targets.
Labor and services market reforms
8. At the core of the competitiveness gap that has built up over time, are dysfunctions and rigidities in the labor and services markets, which can only be addressed effectively through a comprehensive program of structural reforms. The broad debate on these issues launched by the government, with the active involvement of social partners, is particularly welcome. It creates a unique opportunity, which should not be missed, to achieve a critical mass of reforms that can meaningfully improve the competitiveness of the French economy and its ability to create jobs. In addition to improving the effectiveness of state spending and alleviating the tax burden, the reform agenda should include:
• Improving the functioning of the labor market, to create more cooperative, efficient, and inclusive ways of adapting to change and economic shocks.
• Containing labor costs to ensure a better alignment of wages to labor productivity.
• Allowing more competition in the services sector, to improve the purchasing power of households and reduce input costs for enterprises.
Functioning of the labor market
9. Consistent with the mandate given to social partners as part of the social dialogue, we consider that reforms should cover:
Ø Creation of more adaptable work and compensation arrangements at the enterprise level that would increase the capacity of enterprises to respond to market conditions and thus ultimately protect and create jobs. The prevalence of conflictual rather than cooperative approaches has only aggravated the social cost of adjustment and adaptation to shocks.
Ø Removal of the judicial uncertainty associated with layoffs, which raises the implicit cost of labor, creates disincentives to hire, and promotes reliance on temporary work arrangements. In turn, this leads some workers to bear an uneven share of uncertainty, and undermines incentives for employees and employers to build lasting relationships.
Ø Better targeted training by redirecting efforts to the low-skilled unemployed, and reinforcement of active labor market policies through Pôle Emploi (the unemployment agency), i.e., job search and placement.
Ø As cyclical conditions improve, adjustment of unemployment benefits to increase incentives to work.
10. A reduction in social security contributions of employers could contribute to an improvement in competitiveness, if properly financed, if applied across all sectors, and if supported by the structural reforms described above. In the absence of these conditions, the benefits would be quickly eroded. The most effective way to finance a reduction of employer social security contributions would be through a commensurate reduction of expenditures at the general government level. The stronger containment of spending recommended above could conceivably be used to this end. Alternatively, shifting the cost of social security contributions from employers to income (for example through the CSG) is unlikely to have durable effects if it is not accompanied by productivity gains that allow for real wages to recover the loss in purchasing power over time. It would also have undesirable effects on investment, by raising taxes on income from capital. A more promising avenue would be to shift the burden to indirect taxes (for example VAT, property taxes or excises), part of which would fall on imported goods. Again, the effectiveness of such a measure would depend on a parallel effort at wage moderation, notably in terms of the SMIC (minimum wage).
11. The government should support wage moderation, specifically as it concerns the SMIC. As amply documented, the level of the SMIC, its uniformity across sectors, and its indexation mechanism all contribute to a difficult integration of low-skilled and young workers in the labor force. While government programs have helped reduce the related social costs through special employment schemes and reductions in social security contributions, these actions are very costly.
12. Greater competition in the services sector could provide a significant competitive boost to the economy as a whole. Services remain more regulated in France than in most other OECD countries, notably in transport, professional services, and retail commerce. The counterpart tends to be higher prices (for households and enterprises), owing to lower productivity or higher rents. Even though most services are not themselves exposed to international competition, they are important inputs into sectors and industries that are exposed. For instance, about one third of all inputs consumed by industry comes from the services sector. The impact on prices of the entry of a fourth mobile phone operator illustrates the potential benefits of increased competition. By raising the purchasing power of households, deregulation of services would also support the labor market reforms discussed above.
Financial stability and intermediation
13. Financial stability concerns, which arose in connection with euro area tensions and dollar liquidity problems in 2011, have abated considerably. French banks have moved aggressively to improve their solvency ratios and funding structures through retained earnings and disposal of international non-core businesses. Banks are well positioned to comply ahead of schedule with internationally-set capital requirements. Banks are also better placed to handle the impact of low economic growth on asset quality, as well as market and liquidity tensions, although their high exposure to wholesale funding could be a source of vulnerability in the event of another severe liquidity or euro area confidence shock. Even so, French banks still appear to have the capacity to dispose of non-core assets in the event of pressures, without compromising their core lending activities.
14. The resilience of French banks contributed to sustaining positive domestic credit growth through the crisis, but ongoing international regulatory changes call for an overhaul of the tax treatment of financial income to enable the continued effective intermediation of savings to the economy. In stark contrast to banking sectors elsewhere, French banks were able to effect considerable deleveraging without curtailing domestic credit growth. The main constraint on the banks’ capacity to provide long-term financing could come from more stringent regulatory liquidity requirements. At the same time, insurance companies may also reduce investments in equity in response to new regulations and accounting standards. The conjunction of these two factors raises the question of how the financial sector (dominated in France by these two types of institutions) will channel savings to meet the long-term financing (including equity) needs of enterprises. The overhaul of the financial taxation of savings envisaged by the government should be an important instrument to address this challenge by creating a more level-playing field among financial instruments and increasing incentives for long-term saving.
The mission would like to thank the authorities for their welcome, their constant availability, the quality of the analyses we received, and the openness of the discussions.