Mission Concluding Statement 

1. France's recent economic performance and short-term prospects are distinctly positive. The economy is now in the midst of its third consecutive year of strong output growth with low and stable inflation. A most welcome feature of this upswing has been the pace of job creation and the fall in unemployment. There are no signs that demand is weakening and we expect vigorous output and employment growth to continue through next year.

2. While this performance has no doubt benefited from supportive monetary conditions and a favorable external environment, it also owes much to policies and developments that have been at work for some time and that are now bearing fruit in a propitious macroeconomic environment. First, policy reforms over the past several years have induced important structural changes, and the flexible employment response to the economic expansion is the most striking evidence in this respect. Second, wage moderation, which dates from the mid-1980s, has gradually improved the competitiveness of the French economy; this moderation has so far been preserved in the recent upswing. Third, expectations of price stability are now well established, the reward of a long period of stability-oriented monetary policy.

3. There are external risks to our upbeat outlook, notably the possibility of a sharp deceleration of growth in the U.S. economy, but the domestic risks are of greater significance and policy relevance. Two such risks—regarding fiscal policy and structural impediments to growth—have echoes in events of a decade ago, when the upswing ended abruptly. First, the structural deficit may deteriorate even as strong economic activity temporarily narrows actual deficits, providing undesirable fiscal stimulus as well as leaving the public finances in a poor position to deal with the looming consequences of population aging. Second, there is the risk that supply-side constraints will choke off growth and spark inflationary presssures. Although tensions do not appear to be such as to impede growth in the immediate future, signs of labor-supply bottlenecks are beginning to emerge in certain sectors and occupations, and industrial capacity utilization has risen above historically normal rates. In addition, a less propitious feature of the upswing has been that business fixed investment, though rising, has not been as strong as might be expected given the stage of the cycle and the apparent shortfall of capital formation during much of the past decade. We would judge that margins of slack in labor and product markets will have been exhausted by end-2001. At this point, a number of other events will begin to coalesce, including the application of the law on working hours reduction to small firms, the expiration of the moderate wage settlements that marked the initial wave of 35-hour agreements, the full phasing in of the limits on overtime for large firms, and of course legislative and presidential elections.

4. Against this backdrop, the policy requirements to sustain the recovery are clear: a fiscal policy that takes advantage of the upswing to move rapidly and decisively to a position of structural balance; and policies that expand capacity, especially labor supply. These requirements are also in line with what is needed from a broader euro-area perspective. In an economy as large as that of France, excess demand stemming from fiscal stimulus and supply constraints will only increase the pressure on the European Central Bank to raise interest rates. We have been encouraged in our discussions by the convergence of views on the current policy requirements. At the same time, more needs to be done to rally political and popular support, and we are concerned that a perceived lack of such support may impede the translation of policy views into timely action.

5. Turning to fiscal policy, there has been considerable progress since 1997, particularly in terms of reducing the general government budget deficit. This has been due, however, largely to strong economic growth, and the structural budget balance has shown little improvement. Despite its favorable cyclical position, in 2000 France is set to record the second highest fiscal deficit and to provide the largest positive fiscal impulse in the euro area. For 2001, we estimate that the official deficit target implies a further slight deterioration in the structural balance. Indeed, by the Stability Program's own calculations, the structural deficit will still amount to 0.8 percent of GDP in 2003, by which time we project that two-thirds of the euro-area countries will be in structural balance or surplus.

6. Considering both domestic and euro-area policy needs, we think it desirable for France to aim for a budget deficit of under 1 percent of GDP in 2001 and to achieve balance in 2002; this would imply structural balance in 2002 or certainly by 2003. We support the authorities' plans to reduce the tax burden over time, and thus feel strongly that the deficit adjustment should fall on expenditure growth. This will not be easy to do. To achieve our deficit recommendation, we estimate that real general government expenditure growth would have to be held to about 1 percent in each of the next two years, versus 1.3 percent envisaged in the Stability Program. In these circumstances, and following what we judge to have been an overall unsatisfactory outcome of the debate over the 2000 supplementary budget, the commitment to devote any further windfalls to deficit reduction in 2000 is particularly appropriate, and we would regard a similar commitment for the next two years as an important step forward.

7. These considerations place the focus squarely on the multi-year real expenditure norms. This framework is welcome since expenditure control is the prerequisite for sustainable reductions in both the deficit and the tax burden; indeed, tax cuts should be conditional on assurance that, at least, the announced expenditure norms can be achieved. The French expenditure target system is new, and issues of practical implementation have arisen. An issue for the credibility of a multi-year expenditure control program is the failure to reverse the significant slippage in 1999 in the subsequent Stability Program. In addition to incorporating the slippage, that program increased slightly the real expenditure growth norm. Apart from this, there have been persistent pressures on expenditures, particularly in health care outlays, where developments continue to be worrisome. Also, a number of possible reforms—including changes to the unemployment insurance system proposed by the social partners, the results of the last conférence sur la famille, and an earned income-tax credit—may entail increased outlays.

8. The framework for fiscal policy could be strengthened on both the expenditure and revenue side. In this regard, the intention of the government to increase budgetary transparency is welcome. Particular attention should be paid to clarifying the relationship between targets and outcomes at the level of both the general government and its sub-sectors, and to ensuring continuity from one stability program to the next. Concerning expenditures, it seems clear that control in the years ahead will hinge on substantial public-sector reforms. The wave of retirements anticipated over the next decade or so will provide an opportunity to implement strategic decisions regarding public services by restructuring and, where appropriate, reducing public-sector employment. The use of contrats de gestion should continue to improve the management of the public sector budget, and should be broadly extended. For its part, the health-care sector will remain a chronic source of spending pressure in the absence of deep-rooted structural reform. On the revenue side, it would be helpful to have clear principles governing the disposition of windfalls. In general, these should be devoted to deficit reduction, ensuring the operation of the automatic stabilizers. In the same vein, the legitimate desire to reduce the tax burden over time should not lead to an excessive focus on year-to-year movements in the tax-GDP ratio, which is affected by cyclical and other transitory factors.

9. The job-rich expansion of the past few years testifies to the effectiveness of a number of the measures already put in place to favor employment. With margins of slack diminishing rapidly, however, these measures may not prove sufficient to ensure the increase in labor supply needed to sustain growth. In addition, the total budgetary cost of the array of employment-support programs is now quite high. In the immediate future, priority should be given to further reform of the tax/benefit system, to favoring work over inactivity, and to flexible application of reduced working time.

10. There have already been commendable reforms to taxes and benefits. These include the targeted reductions in social security contributions, and changes to the taxe professionnelle, the taxe d'habitation, and the aides au logement. We welcome the emphasis on the supply side in the discussions of the 2001 budget, and the planned longer-term reduction in the tax burden should remain firmly focused on strengthening incentives to employment and raising the supply response of the economy. Furthermore, the approach to tax/benefit policy would gain from the development of a multi-year strategy as a complement to the multi-year expenditure targets. Such a strategy should deal with several areas: further reduction in unemployment traps, especially on the benefits side and possibly including an earned income tax credit; reductions in high marginal income tax rates, especially at the higher end of the tax schedule (the 2000 supplementary budget having already implemented reductions at the low end); and reform of business taxation to promote investment and to preserve France as an attractive business location.

11. High rates of long-term and youth unemployment and high non-employment among the old suggest a need to improve the effectiveness of mechanisms to move people from inactivity to market employment. The RMI seems to have been unsuccessful in this role, and it is particularly disturbing that the number of beneficiaries continued to rise in the midst of a boom. This program should be reoriented toward its original goal of temporary support. The recent agreement by social partners on the unemployment regime proposes to increase the prospects of an early return to work, which is surely a step in the right direction. However, an important factor in its practical implementation will be needed improvements in the effectiveness of the public employment service. The time has also come to reconsider the role of public-sector and subsidized employment programs, including the emplois jeunes. In a buoyant labor market, such programs are unnecessary to stimulate employment and risk aggravating shortages of labor in the private sector. Finally, raising the labor-force participation of older workers will require changes to pension arrangements, including the ones penalizing those who work beyond the age of 60, and improvements in the opportunity and effectiveness of life-long training.

12. The reduction of working time is by far the most prominent labor market initiative in recent years. To date, it has proceeded relatively smoothly, and the promise of a broader dialogue between the social partners has been fulfilled. We have always taken the view that flexibility in the application of this measure is vital, and this point has become of pressing importance. The 35-hour law was conceived and launched at a time when absorbing excess labor was the principal policy concern. But, in currently tightening labor markets, reduced working time aggravates labor shortages and threatens to put upward pressure on wages. These observations lead us to conclude that the case for expanding allowable annual overtime hours has become compelling. The mechanical effect on the minimum wage implied by the indexation rules will also put upward pressure on wages. The government should therefore continue to avoid any discretionary increases (coups de pouce) to the minimum wage. Finally, in 2002, the reduction in working time will be extended to small firms, which have much less scope to rearrange work practices, and the authorities should consider ways to ease the impact on these firms.

13. There has undoubtedly been a welcome evolution during the past several years in the public understanding of the consequences of population aging and, in particular, their impact on pension programs. Fundamental reform remains elusive, however, and it is now time to take measures to put the pension system on a sustainable footing. In March, the Prime Minister proposed initiatives that are worth pursuing as a first step. These include extending the contribution period required for civil servants to receive a full pension, the allocation of assets to a pension reserve fund (Fonds de Réserve pour les Retraites), and the establishment of an ongoing advisory body on pensions. The last two are being implemented, although the fund, which as proposed will be relatively small, should not be regarded as a substitute for more fundamental reform. Another potentially helpful innovation is the reform of wage-based saving plans (the introduction of PPESV), which will enlarge the menu of long-term savings instruments available to workers.

14. In product markets, there has been great progress in privatization, but much less in opening up the key network sectors of electricity, gas, and transportation. In these sectors, EU directives have generally been transposed in a tardy and often minimalist way. Yet, in areas where there has been privatization and liberalization, notably telecommunications, the benefits have been immediate and substantial. If France is to fully reap the benefits of rapidly advancing technologies, greater progress will have to be made in increasing the dynamism of product markets through deregulation and further measures to promote entrepreneurial activity.

15. The financial sector continues to evolve rapidly, in France as elsewhere, and is benefiting from the cyclical upswing. However, some aspects of the French financial system appear to be increasingly outdated and should be critically reviewed, notably deposits with government administered interest rates and the prohibition of interest on sight deposits. A Fund mission, which took place at about the same time as the Article IV mission, found in its preliminary conclusions that the French system meets the requirements of the Code of Good Practices on Transparency in Financial Policies, although it did recommend that objectives of insurance supervision be aligned with those of other sectors to ensure efficient coordination.

16. In summary, the key policy challenge is to ensure the continuation of sustained noninflationary growth. Among policy makers there appears to be a broad consensus on what needs to be done: sustainable improvements in the fiscal position and structural reforms to improve labor and product market performance. Implementing such policies has always been difficult, but the economic climate is now unusually favorable. At the same time, the need for reform is unusually pressing: strong economic growth beyond the next year or so can be sustained only by easing aggregate supply constraints, and the fiscal effects of population aging will begin in only five years' time. The program outlined above is ambitious, but in the current circumstances we believe the benefits of decisive action will be large.