France tries again

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Is there a reason French has so many expressions for going round in circles? Déjà vu, plus ça change, and there is even a Québécois jour de la marmotte (groundhog day). Whatever your pick, the reality that has returned like an impossible-to-kill zombie is of a French government toppled by its inability to rally a legislative majority behind a budget consolidation.

This week, that fate befell François Bayrou. Within a day, Sébastien Lecornu became President Emmanuel Macron’s seventh prime minister, and faces exactly the same challenge as several predecessors of fixing public finances without a parliamentary majority. Same problem, same question: how did we get here?

It is well known that France has the third-highest public debt-to-GDP ratio in Europe, although some way behind Greece and Italy. Investors, however, demand no markedly higher interest rate to lend to those two countries’ governments than to France’s (a lower one, in fact, in the case of Greece).

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This reflects the fact that France’s public finance outlook has worsened in ways the others haven’t. How? I asked this question almost exactly a year ago — journalists have groundhog days too — when Michel Barnier (the previous prime minister but one) replaced Gabriel Attal (previous but two). Below is an updated version of a graph I used then to highlight what is different about France. It displays the public debt-to-GDP ratio but normalised to 100 in 2013 to make it easier to see the different evolution of different countries since then.

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It shows that France has increased its public debt ratio by more than any of the other largest Eurozone economies, and that this deviation took place in two phases.

In the recovery after the global financial crisis up until 2019, France’s debt ratio drifted slightly up, as did Italy’s and Spain’s. In contrast, German and Dutch public debt ratios fell steadily. In the pandemic, every government indebted itself to rescue its economy. Since then, however, Rome and Madrid have outdone Berlin and The Hague in terms of public debt reduction — but Paris, uniquely among large Eurozone economies, has not.

Two periods of drift, then, the second lonelier than the first. What happened? The next chart maps out the deviation in French public finances from the Eurozone average. We can see both periods of drift where the excess of France’s deficit over that of its peers goes up. That first happened in the past decade until about 2017, when France began slowly converging back towards its peers. Then it started deviating again in 2023.

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The French state has long had a bigger imprint on the economy than other European states. But in the years to 2017, Paris became a significantly bigger outlier in this regard. And it is clear that it expanded state spending more than state revenues, again relative to Eurozone averages. In other words, it probably isn’t possible to swell France’s already bloated state any further and fully fund it through taxation.

Conversely, the reversal in that dynamic coincides with Macron’s arrival at the Élysée, and the Macronist project can be clearly seen in the chart: it has been to make the French state more similar to the rest of Europe from the perspective of public finances. And he has been largely successful! France’s above-average levels of spending, revenue and deficits were all coming down steadily from 2017 — with punctuated rises for the pandemic and the energy crisis — until about two years ago.

Some conclusions can be drawn from this that nuance the conventional complaints about French profligacy.

First, until two years ago, that profligacy was extreme even by European standards, but not unsustainable: the debt-to-GDP ratio was constant or slightly declining.

Second, France has options: as the charts above show, it has both increased and decreased the size of state spending and revenues in the past. The fact that the last successful reining in of deficits coincided with falls in the tax take — and strong employment growth — should encourage politicians to resist the temptation of closing deficits with too many revenue-raising measures. Indeed, fiscal reform could usefully include some tax cuts as well, in particular for taxes on work. According to the OECD, France has some of the fattest tax wedges on labour income of all rich countries.

Third, France’s high debt is largely a consequence of accumulated deficits — that is to say, political choices — rather than the self-reinforcing “snowball effect” of interest rates exceeding growth rates. This point is explained in detail in a note from last year by France’s official Council of Economic Analysis, which recommends aiming for a 1 per cent of GDP primary surplus in the medium term:

The good news is that France has so far remained in control of its own destiny. Our debt is the direct result of our budgetary choices . . . The bad news is that we should not expect a macroeconomic miracle. Indeed, it is highly unlikely that inflation or growth will systematically reduce public debt without a budgetary effort . . .

Fourth, “sustainable” here is, therefore, conditioned on interest costs not ballooning. If interest rates were locked in and growth certain, it would be possible to argue that France could have maintained its circa 2023 fiscal position so long as it did not let it slip further. But there are two sources of upward pressure on interest rates, one controlled and one uncontrolled.

The controlled pressure is the phasing in of today’s rates — much higher than over the past decade — as government bonds expire and have to be refinanced on new, more expensive terms. France spends about 2 per cent of GDP on interest costs; about the Eurozone average. But that has nearly doubled since the start of this decade. The government’s 10-year borrowing rate is now about 3.5 per cent, when it was zero back then. If today’s rates persist, or even go down a little, Paris will still have to pay several percentage points more of GDP in interest in due time.

The uncontrolled pressure would be that rates don’t stay at current levels and enter a self-fulfilling spiral, with investors worrying about public finances, demanding a higher premium for risk, worsening public finances as a result, and so on. This is what happened to governments across the EU south and Ireland in the Eurozone debt crisis. Because of that experience, it is not going to happen again, or not in the same way. The European Central Bank would use its still-shiny (from never being used) bond-buying “transmission protection instrument” if things got bad enough.

That is a prediction about what would happen in terms of financial mechanics. How it would be managed politically is the wide open, trillion-euro (literally) question. In particular, the politics of the ECB judging that Paris was in compliance with the conditions for its support, and the politics of other member states tolerating whatever Paris and the ECB were doing, is very hard to predict apart from being painful beyond belief.

That is the spectre Bayrou should have raised, rather than having to go to the IMF, which never made a lot of sense. The French political and technocratic system had a near-death experience when, in the summer of 2011, it looked like markets might lump France in with Italy. Some of the urgency that caused could be useful today, as could learning from the countries afflicted back then (the Council of Economic Analysis points out that Portugal achieved strong fiscal consolidation while raising social protection spending). Being lumped in with Italy is starting to look like it would be a lucky break.

France tries again

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