France – The question asked by Standard and Poor’s

France has been downgraded by Standard and Poor’s last Friday (November the 8th). I have written on this issue (see here) but due to controversies I have to complete my explanation.
The best way to highlight the issues France has to face is to look at a simple graph. The chart below represents GDP per capita at 3 different periods after a recession. The first is the first oil shock in the mid-70’s, the second is the aftermath of the European Monetary System crisis in the early 90’s and the third is the current episode.
GDP per capita is at 100 at peak of the business cycle.

Looking at the graph we see that the first two exits from recession are comparable. After nine years GDP per capita is almost 15% higher than at the peak cycle. In the current period this is clearly not the case. GDP per capita in 2015 will probably be below its 2007 level. (GDP is close to its pre-crisis level but not the GDP per capita). This issue is not due to S&P forecasts as they are close to the consensus. (Even if figures are more optimistic the global picture is unchanged).
The current question for France is this one: what can explain the gap between the current  and former profiles and what has to be done to reduce it and at the end to improve the labor market behavior.

On this point Standard and Poor’s considers that short-term economics policies are not the good answer to converge rapidly to a higher GDP profile. The agency thinks that taxes are too high to improve the situation and that structural reforms are necessary.
The rationale behind this point is the following:The French economy environment has deeply changed and the current crisis has a strong persistence that modifies behaviors. So France has to adapt to this new situation.
On the other side Paul Krugman said during the week-end (see here, here, here and here) that France’s behavior was not too bad. He backed current economic policy options of higher taxes as it was probably a more efficient framework than lower expenditures linked to the social model could be. Krugman doesn’t say that everything is working nicely in France but he doesn’t find clear justifications for it in the current situation. He thinks that the downgrade reflects the clear disagreement between government’ options and S&P wishes to reduce the social model.

Nevertheless, the question is the following: Will France be able to converge endogenously to a higher trajectory that could lead to full employment? That’s the question we must ask looking at the chart.
If we think that spontaneously France will recover and converge to this trajectory then stabilization policies are the correct answer to current uncertainties. This means that with less restrictive fiscal policies growth momentum will spontaneously be stronger.
If we think that the France current environment has deeply changed with new competitors and new rules, then probably some structural adjustments are necessary. This means that spontaneously the French economy cannot converge to full employment. In the short run this implies that France momentum will depend deeply on France economic partners.

I’m persuaded that strict fiscal policies for the Euro Area since 2011 were not the good answer. They have had very negative impacts on growth and employment, but we cannot do as if the current crisis was just a business cycle downturn. The chart shows that it is deeper than a simple recession. The world changes deeply and the French economy and people in France have to adapt to this new environment. As Krugman said in one of his post, France is close to the Euro Area average. This is not satisfying as it puts France more as a follower than as a leader.


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