PARIS — International investors are bullish, Wall Street bankers ecstatic, French business leaders full of confidence. And above all, Angela Merkel is happy.
Less than a year after he took office, President Emmanuel Macron has ample reason to boast about France’s economic rebound. As happened across the eurozone, French GDP growth was much stronger than expected last year — estimated at about 1.6 percent on an annual basis, a big jump from 2016’s 1.1 percent. And growth should be solid again in 2018.
Macron’s determination to reform is being taken seriously in France and even in Germany, which has long been skeptical of French presidents’ reformist proclamations. Later this year, however, long-standing economic fragilities could reveal some chinks in the president’s armor.
Government officials aren’t too worried for now and point out that all the components of growth give reason for optimism. As consumers buy and companies invest, new jobs are created and new businesses launched in numbers unseen since the beginning of the financial crisis.
“What’s worrying is that we’re falling behind other eurozone countries” — Emmanuel Jessua, economist
“We’ve created the ambience. Macron’s policies, notably last year’s labor reform, have played a central role in making France the hot European story for world businesses,” said a government aide. “Saying that isn’t being complacent. We know that much remains to be done.”
But France’s improving growth story so far is relative, and hardly Macron’s achievement. GDP rose last year much faster than expected everywhere in Europe, and France’s uptick was, in fact, below the eurozone average of 2.5 percent. The global recovery, which saw all the world’s major economies growing together for the first time in years, set the backdrop. And in Europe, it wouldn’t have been the same without the European Central Bank’s loose monetary policy, which kept interest rates at record lows and allowed eurozone banks to boost lending.
In France, most of the recovery is also due to the reforms initiated back in 2014 by the government of former President François Hollande — notably significant cuts in labor costs, which were reduced to be closer to German levels.
Rendezvous with problems
The president could send a thank-you note to Hollande and ECB President Mario Draghi for 2017. But in 2018, the economy becomes all his. After another year of growth, job creation and possibly further reforms, Macron has a rendezvous with a few unsettling problems at the end of the year.
For one, even though exports have started to pick up again, exporters keep losing global market share, as they have since the beginning of the crisis.
“The problem is that French exports aren’t just losing market shares to, say, China or the big emerging economies,” said Emmanuel Jessua, an economist at COE-Rexecode, a business-financed think tank. “What’s worrying is that we’re falling behind other eurozone countries” — to below 13 percent of the eurozone’s total exports last year from about 17 percent in 2000.
Rising labor costs in the last 15 years have reduced France’s industrial base and prompted businesses to slash investment spending, which in turn reduced their capacity to innovate and compete on world markets, according to Jessua. The result: French products are seen as too expensive and not offering enough value.
As economists have long noted, that makes them too vulnerable to price changes that can be brought about by currency volatility — for example, the strong euro, which is currently making eurozone goods more expensive abroad.
A second possible weak spot of the French economy lies in the high debt of the private sector, which is often overlooked in the discussions at the EU level about public debt and the need to cut fiscal deficits.
Since the beginning of the crisis in 2007, French corporate debt has shot up from 141 percent of GDP to 168 percent, said Gilles Moec, Europe economist at Bank of America Merrill Lynch. That’s the highest level among the eurozone’s top economic powers, surpassed only by Portugal and Belgium.
The problem is not that French companies are vulnerable to a market scare that would send interest rates soaring: Their debt is mostly long-term, at fixed rates. But a global slowdown that would cause a fall in exports might force them to cut down debt in a hurry, triggering a vicious cycle of demand contraction. This scenario is not, for now, on the radar — but neither was the 2007 financial crisis on anyone’s a few months before it struck.
Another French economic flaw is that as growth picks up, the gap between the skills of the workforce and business needs is becoming apparent. Bottlenecks have appeared and a rising number of companies complain about not being able to fill job vacancies. Structural unemployment — the part of unemployment that doesn’t depend on economic cycles — is possibly as high as 8 percent.
The government has launched major reforms of the country’s inefficient and costly training and apprenticeship systems, but those are long-term actions that won’t produce significant and visible results in the next few months.
Then there are the areas where Macron the reformer remains untested. The main one is what he intends to do with France’s public finances.
The French government has never balanced a budget since the early 1970s — before Macron was even born (in 1977). And he hasn’t promised to bring it back to German levels. His moderate campaign pledge was to abide by the EU’s stability and growth pact — that is, keep the budget deficit under 3 percent of GDP by whatever means, then take it down to 1 percent by 2022, the end of his presidential term.
Nothing has happened so far, and some have begun to doubt the French president’s commitment to make it happen.
The absence of decisive action was expected. Macron always said it would take time to identify the areas where public spending can be cut. He has appointed a commission that should publish in a few months its conclusions on how best to cut €60 billion of annual spending in public accounts — €25 billion for the central government alone, and the rest coming from cuts in local government spending, the health care system, and unemployment benefits.
French President Emmanuel Macron | Ludovic Marin/AFP via Getty Images
“That will be a litmus test because he is not at heart a free-marketer, small government politician,” noted one of Macron’s former teachers at ENA, the elite school for civil servants that he attended in the 1990s.
The main problem is that, in a country where public spending amounts to 56 percent of GDP (a eurozone record), savings can’t be incremental. “You have to really go after the three big sacred cows of government spending: vocational training, housing benefits, and our so-called pro-job policies,” said one of Macron’s former advisers.
So even in the absence of bad economic news, the last months of 2018 when the government publishes its 2019 budget will prove crucial for the French president: Macron will be tested in his bid to be taken seriously on the fiscal front — though he may hope to benefit yet again from a fiscal windfall generated by stronger growth.
That will be all the more difficult ahead of a big election year. Macron is devoting to the European Parliament election a political energy unseen in a French president for such a vote. Can he refrain from the largesse that is customary in campaign years?
Next year’s budget will test Macron’s political fortitude — and the international credibility needed to drive the European reforms he advocates.