The new government is expected to give a new breath to French economic policy. Manuel Valls the new prime minister will give a speech tomorrow at the National Assembly and we can expect that he give economic policy targets and how to reach them.
At the same time, Michel Sapin the new finance minister will have to negotiate with the European Commission the budget deficit trajectory. It was expected at 4.1% in 2013 but it will be at 4.3%. The target for 2015 is 3% and is probably not reachable. There are still discussions on the “Pacte de Responsabilité” that was announced by Francois Hollande during its press conference on January the 14th. This “pacte” will reduce payrolls tax. There are still discussions on the definition of the “pacte” and on who will finance this charge reduction? It will probably be financed by a reduction on government expenditures by EUR 50bn but the negotiation is not over yet.
On these issues, a macroeconomic point of view can improve the understanding of the situation. The two charts below will help.
In the long run, GDP profile is conditioned by private demand.
On the chart below, the French GDP is the purple line. The three other lines are contributions from Private demand, in blue, government demand, in red, and net external demand in green. (I have excluded inventories). Each line represents the sum of quarterly contributions through time. Every line is based at 100 in the first quarter of 1999. So the period starts with the inception of the euro.
The chart clearly shows that the GDP profile is conditioned by the private demand. Government demand has a positive but monotonic increase of its contribution. Contrary to private demand there are no fluctuations. Net external demand has a negative contribution which is consistent with larger external deficit on the period.
There are no surprises in the decomposition.
In the shorter period that started with the crisis, we have a very different picture.
The starting point (base 100) is the first half of 2008, just before Lehman Brothers bankruptcy.
In this short time period, GDP is just back to its pre-crisis level during the last quarter of 2013.
The private demand contribution is still negative at the end of 2013. Private demand during the crisis period was a drag to GDP growth. This was mainly due to low investment. Net external demand is neutral. The interesting point is that government demand has grown at almost the same pace than before the crisis.
In other words, GDP growth came from public demand and not from private demand.
The complexity of the French economic policy comes from this new hierarchy.
When Brussels asks for a lower deficit, this could lead to a lower government demand. The risk then is to have a negative impact on GDP momentum. Looking at the decomposition of French growth, we understand why French governments, since the beginning of the crisis, are reluctant to reduce expenditures.
Discussions with Brussels will be on deficit but also on the hierarchy between private and public demand. One failure in the French economic policy is the impossibility to improve rapidly private demand and let the adjustment to be done by the government demand.
One target of the “pacte de responsabilité” is to give companies the capacity to improve their own situation and the possibility to catch up the global economic cycle. If companies are in a better shape, via an improvement in margin rate,, they will be able to join the global recovery. The positive aspect will be a strong impulse for the French economy. This could at the end change the current demand hierarchy. Beside this specific momentum, there is the question on the funding of the “pacte”. Public expenditures were at 57.1% of GDP in 2013. Brussels will not accept a supplementary increase. This means that there is a need to stabilize or to reduce them and to reduce expenditures by EUR 50bn. The funding of the “pacte de stabilité” will go through lower expenditures.
Private demand and government demand will intersect in the future. But probably, the later the better as current outlook is still very dependent on government demand.
The stronger private demand could go through incentives for consumers or for companies. Currently, it would not be efficient to go through households. Last year, there was an interesting situation. There exists an instrument of profit-sharing in France (l’épargne salariale). The rule is that employees have to keep this amount of money on a specific account for five years. But from time to time a government wants to use these important amounts to support consumption expenditures. That’s what was done in 2013. It was not a success. Households have kept their saving on their account and have not spent more. A stimulus policy that, at this moment of the cycle, goes to consumers would probably be counterproductive and would fail to boost economic activity.
That’s why the stimulus have to support companies and at the end companies’ investment. During the crisis, companies’ margin rate dropped and has still to recover. The government measure, “le pacte de stabilité” will help to improve companies’ situation and give the possibility for them to catch up the current global recovery.
The issue for the French economic policy will be to change the hierarchy of demand contributions to GDP growth. The new government will have to manage the transition. That’s why “la feuille de route”, the economic policy agenda that Manuel Valls will define in his speech will be important. Expectations are high