“There is a 20 century-old pact between the greatness of France and the liberty of the world.” — Charles de Gaulle
France is screwing itself. And the problem is that if it screws itself, it screws the world.
Market fears are spreading to France. CDS spreads on French debt are rising. The time to act is now, and yet French policymakers are doing everything wrong.
Right now, as in many times before in world history, if France fails the levee breaks. If France fails, the Eurozone bailout fund fails. If the Eurozone bailout fails, Europe goes to hell in a handbasket, and if it goes so goes the world economy.
France’s policymakers are keenly aware of this. And they plan to act. But they’re going about it precisely the wrong way.
Prime Minister François Fillon unveiled yesterday a tough austerity plan, with spending cuts, taxes on high earners, and a balanced budget amendment to the Constitution. Except that we’ve seen how austerity works out: it takes out the economy at the kneecaps. GDP growth slows, or reverses, which only makes the deficit worse. The last time France tried austerity in 1995, tax receipts went down and the deficit went up (and the government got crushed at the following election).
So, what to do? How can France reassure the markets as to its capacity to pay its debt without sinking into austerity, and thereby doom Europe (and the world)?
There’s only one good way to reduce deficits and debt over the long term: growth.
And France has plenty of growth potential. It has the best infrastructure and the most productive workforce in Europe. It just happens to be extremely overregulated and overtaxed.
When a country is driven to desperation by the bond markets, here’s what generally happens: the bond markets and the IMF impose two things: austerity and devaluation, and pro-market reform. Because austerity and devaluation are painful, the reforms don’t really work, at least at first, and “neoliberal” reforms are associated with pain in the mind of voters.
But except when there’s a bond crisis and the country literally cannot finance itself, there’s no reason why austerity and reform should go together.
In fact, reform is the best way to avoid austerity. So to avoid a bond market showdown and thereby save the Eurozone (and the world), the French government must convince the bond markets that it is reforming for growth.
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So here’s what France’s President must do:
- Announce a far-reaching plan of regulatory reform. Everything must go, with particular attention to the absurdly regulated labour market and to professional guilds. Everyone knows what must be done. President Sarkozy himself convened together a committee of economists, the Attali Committee, whose sensible report was shelved as soon as it was published. Comically (or tragically, depending from your perspective) many of its proposals echoed the proposals of the Rueff-Armand Committee from 1959 (!!). Everyone knows what must be done.
- Pass by decree (or ordinances, as the French Constitution allows) a brand new, revenue neutral tax code that broadens the tax base and gets rid of all but the most popular of the many tax breaks, like the special 5.5% VAT rate on race horses or the exemption of old furniture from the wealth tax (seriously, these exist). The new tax code would also drastically reduce the taxes on work, and possibly reverse some of the most absurd tax cuts enacted by the Sarkozy government.
- Hand over the implementation of this plan to a hand-picked group of highly internationally respected technocrats, and give them far-reaching powers under the law to strike down or suspend regulations.
If he must, the President should consider exercising Article 16 of the Constitution, the war powers clause, to push through the agenda. It would be constitutionally iffy, but the French supreme court leans conservative.
This plan would tackle the root cause of the deficit: highly sluggish growth for the past 30 years, brought on by overregulation of the economy. It would convince the markets that France is serious about reducing growth, and therefore its deficit and its debt. It would convince them, more broadly, that there is still life and blood flowing in the veins of the Eurozone and so its currency and its debt is still worth holding.
But wait, is it that easy? No, of course not. Otherwise any government would have implemented these reforms already.
The problem is, of course, that all these reforms are blocked by interest groups who can go on strike overnight and freeze up the country, and that the government is already heavily unpopular.
That’s the problem with austerity-induced reform: pusillanimous governments only reform when they have no choice and have to do it in the midst of austerity, and so these reforms end up being very unpopular.
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Thankfully, there is a solution. Economists Jacques Delpla and Charles Wyplosz have a proposal that is convincing because of its utter simplicity: pay off the losers of the reforms.So for example, it’s impossible to find a (very expensive) cab in Paris because of an incredibly restrictive, absurd medallion system. The reason why no one is able to do anything about it is because taxi drivers (rightly) believe that if the medallion system is opened up, their own medallions, which they have paid handsomely to buy and intend to sell to finance their retirement, will become worthless. And so whenever someone threatens to do something about the medallion system (or even mentions it), they all go on strike, block the main Parisian roads with their taxis and bring the city to a standstill, and the government caves. And in a sense, they’re right to go on strike: even though they’re screwing the rest of the world with their inobduracy, no one willingly gives up 99% of his equity. So, the solution is: pay them off. Pay them the old value of their medallion so they don’t have reason to complain.
Reform is necessary. But reform is painful for the losers and they can block reform. So the losers must be paid off. It’s the only way to accomplish reform swiftly (and, in France, perhaps at all). It would be stimulative to boot, but that’s not the point.
Depla and Wyplosz estimate the full cost of reforms to 20% of France’s GDP, but many of the reforms can wait. Pensions and civil service reform and higher education, which would be most expensive, can wait. The idea is to boost GDP, output and employment now, and that mostly entails deregulating markets.
So the committee charged with implementing reforms should be allowed to raise debt backed by the French government up to, say, 250 billion euros, and spend it as it sees fit, with an eye not to stimulus but to greasing the wheels of reform. It should be allowed to suspend any regulation it sees fit, and empower local and regional authorities to try their own reform schemes.
But this is why it’s crucial that the plan be put in place NOW. France still has a AAA rating with a stable outlook recently affirmed by all ratings agencies (absurdly, in theory a better credit than the United States). More generally, the markets still trust France as a core eurozone country. But no one knows how long that will last. If French CDSs rise too much, it won’t be possible to borrow heavily anymore, and the world collapses.
It’s also why it’s crucial to hand over the money and the implementation of the plan to a trustworthy and independent committee. Like America’s, France’s post-crisis stimulus was a set of confused boondoggles of dubious stimulative value. The spending would obviously be stimulative, but that’s not the point. The point is to deeply and thoroughly reform France’s economy, and the bond markets need to understand that’s how the money will be spent, not on boondoggles or even “vanilla” keynesian stimulus.
This bold plan, executed swiftly, would not just help France’s economy tremendously, it would allay the market’s fears as to the Eurozone core. It would also show other countries how they can reform themselves.
By enacting a bold program of reform before the bond markets force it on them, countries would be able to escape searing austerity. If the French experiment works, the markets would probably cut countries like Spain, Italy, Ireland and Portugal some slack and let them reform without having to immolate themselves first.
The last time France stood between the world and the abyss, it was May 1940 and we flubbed it dramatically, by plunging the world in a terrible and completely avoidable war. Even on the eve of defeat, victory was within our grasp: during the phoney war, France’s armoured forces, a match for Germany’s, could have leaped to assault and taken over the strategically vital Rhine region while the Wehrmacht was occupied in Poland, breaking Germany’s back and ending the war.
The reason France failed then was because the proper course required not just decisive, swift action, but a wholesale rethinking of our worldview, based on a (in hindsight useless) defensive posture.
We find themselves in the same position today: what is desperately needed is decisive action and a wholesale abandonment of old, discredited ideas, in this case austerity. And again today, we stand between the world and the abyss.
It’s up to France to raise to the occasion. This time, hopefully, we’ll be up to it.