On August the 14th, the French statistical institute (INSEE) will publish the GDP growth number for the second quarter. During the first three months of this year GDP growth was flat. Q2 estimate will also be close to this number. Households’ consumption is stronger but the industrial production index dropped dramatically. I expect a figure between 0 and 0.1%. But these weak numbers for the first two quarters lead to discussions about the strength of the recovery.
The government forecast was 0.9%; market expectations are now close to 0.5-0.6 % and it is not the worst scenario. To converge to 0.5% for the whole year with 0% in the second quarter then, 0.3% has to be expected for the third and the fourth quarters (non-annualized rate). With 0.1% during spring and 0.3% again in Q3 and Q4 then the average growth for 2014 will converge to 0.6%.
The two numbers are well below the government forecast. Public finances targets will not be attained. The budget deficit will be above 4% (as % of GDP) (3.6% was expected by the government). We can add that the rebound of 0.3% in two consecutive quarters is ambitious. GDP growth could be lower than 0.5%.
We can synthesize the current economic situation in France in a chart. It represents the GDP level, the internal demand level (households’ consumption, investment and government expenditures) and the private demand (households’ consumption and investment by companies and households). The three indicators are based at 100 during the first semester of 2008 (just before the Lehman moment)
What is interesting here is the profile of each indicator. The main point to notice is that the private demand is, at the end of the first quarter of 2014, well below its pre-crisis level. In other words, private demand has been, on average, a drag to economic growth. This is the real issue as on a mid to long-term horizon, GDP profile is conditioned by private demand profile. We also note that internal demand is on a positive momentum. Government expenditures are key to understand the French GDP profile.
French Economic Policy
With that in mind we better understand the French economic policy. One important measure (Pacte de Responsabilité) is to reduce charges on companies to increase their incentives to invest. The government target is the convergence to a more normal hierarchy between GDP and private demand.*
To finance this measure, the government is expected to reduce its expenditures (€50bn by 2017). But we see from the chart that there is a risk on growth if government expenditures are reduced too rapidly.
The two measures cannot work together in a framework of very low growth. The Pacte de Responsabilité is supposed to boost growth while its financing, by reducing government expenditures, will be a drag to it. There is a trade-off in time. It is necessary to improve growth prospects before being able to rebalance public finances. This means that public deficit have to be above target. That will be the task for Manuel Valls, the prime minister, for the coming three years
There is another issue which is the following. The Pacte de Responsabilité is expected to improve companies’ investment. But the main determinant for it is expected demand. Financial conditions are just a necessary condition not a sufficient one. If there is a high probability of a weak demand then it is more efficient for a company to wait before investing. In that case and to complete the Pacte de Responsabilité, the government has to boost its own investment to trigger private capital expenditures. That’s clearly not the case yet.
* In 2013, households had the possibility to use a certain type of saving linked to a profit sharing scheme (this saving is supposed to remain at least 5 years in a specific type of fund). It was not a success; consumption momentum was not stronger after this measure as uncertainty is still high. That’s why the government has targeted companies more than households.