Four Hot Topics for the Summer

Éric Chaney, Economic Advisor to Institut Montaigne, scrutinises the economic subjects that will mark the summer. Germany, China, the French labour market and budget are in the spotlight.

1. Recovery in global trade: jubilant Germany powers ahead. What about France ?

Since 2011, global trade in manufactured goods has been stagnating, which is symptomatic of the weakness of the economic recovery since the 2008 financial crisis. Growth fell from 8% to 2% in the year before the crisis, until an unexpected recovery in late 2016, which, according to the most recent data, restored the annual growth rate to 5%. The French statistical office (Insee) is even predicting that it could reach 6% over the whole year. Such a rate had not been seen since 2006 (this excludes the temporary bounce back that followed the 2009 collapse).

In parallel, business in Germany is booming. According to the manufacturers surveyed monthly by the IFO Institute of Economic Research, business conditions are even better than in the late 1980s, when low oil prices combined with the unification shock were making the German industry work flat out. IFO’s commentary, which usually tends to adopt a restrained style, goes so far as to mention a “jubilant” economic climate !

Is the French industry benefiting from the global recovery in the same way ? Exports of manufactured goods fell by 1.7% in the first quarter after an admittedly strong performance during the three previous quarters. However, the momentum of French exports does not match that of the reinvigorated global trade, which opens difficult questions. Is the French industry suffering from a lack of price competitiveness ? The restoration of profit margins, and the associated reductions in labour costs and production prices in key sectors such as capital goods and transportation equipment suggest otherwise. The answer is likely to lie in some mismatch between French supply and global demand which, ultimately, is attributable to a lack of investment and innovation, since the nature of demand constantly evolves in response to technological innovation.

Restoring the competitiveness of the French economy, in both the manufacturing and service sectors, is not simply a question of cost. No “industrial policy” can effectively replace research and innovation carried out by businesses, due to the global competition in which they evolve. Nevertheless, world class scientific and technological research, and a better training of the labour force, can undoubtedly contribute to improve the competitiveness of French companies.

2. Beijing to be more influential than Washington in the upcoming months

As the 19th Congress of the Chinese Communist Party approaches, political manoeuvres in Beijing are intensifying. No one doubts that the President and Secretary General of the Party, Xi Jinping, will be re-elected for a second term, but the future of the Prime Minister, Li Keqiang, whom many analysts consider to be more in favour of economic liberalisation, is less certain. This matters, because any policy decision taken by China has a rapid and far-reaching impact on the global economy. As such, the 2009 global economic recovery owes a great deal to the massive stimulus initiated by China back then. Today, President Xi’s economic policy is focusing on reining in against corruption, which Chinese social media continues to bring to light despite the power of the Internet police, pollution, and excessive debt. This last point is of utmost importance for the global economy. The arrest of Wu Xiaohui, president of Anbang, China’s second largest insurance company, is more than just another anecdote. With the support of the generous lending policies of Chinese banks, Anbang had made a series of foreign acquisitions while selling short-term savings products backed by underlying assets with longer maturities and poor liquidity. From this point of view, Anbang is a perfect illustration of the concerns of the Chinese Banking Regulatory Commission, which emphasises “systemic risks inherent to certain large businesses.”

Here lies a macroeconomic trap : any attempt to restrain indebtedness by restricting credit (up 12.3% year-on-year in March) risks cooling down the economy, while the central government is reluctant to undertake large-scale fiscal stimulus, and local authorities are paralysed for fear of being exposed to corruption allegations. Even worse, the combination of an economic slowdown with greater monitoring of capital outflows has weakened the Yuan, forcing the central bank to draw on its currency reserves(1) once again to stabilise the currency and, as such, avoid US retaliatory measures.

So far, Chinese leadership has skilfully sailed between recession and debt, enabling the global economy to grow at a decent rate, and even to accelerate in late 2016. However, as the debate around domestic economic policy intensifies, and as the US threatens to launch a trade war, the risk of economic policy blunders grows. As well as the risk represented by President Trump, it is necessary to monitor the economic debates in Beijing closely, with Stephen Roach from Yale University believing that the country is moving away from the path of reform.

3. The French labour market: insights from an Insee survey

Whereas the bill enabling the French Labour Code to be reformed by ministerial decrees was recently approved by the Council of Ministers, Insee’s quarterly review of the French economy (Note de Conjoncture) provides interesting insights on French labour market failures, thanks to a survey of French businesses. Half of companies in the surveyed sample (in manufacturing, building and services, including retailing) said they were facing barriers to hiring staff on permanent or long fixed term contracts. However, excluding those who considered that the question was not relevant to them, because they were not in position to hire staff, 59% of businesses reported encountering such barriers – a significant and worrying drag on growth at a time when the global economy appears to be accelerating. Even more interestingly, Insee asked businesses to provide colours on the nature of their difficulties. Economic uncertainty was mentioned as the most important (28%). Economic policy can scarcely influence this macroeconomic background noise : fluctuations in global trade, exchange rates, and interest rates are global factors over which local policies have little or no influence. As such, this response should not be taken as a call for a fiscal stimulus, as may have been written by some experts. At most, it is worth mentioning that the survey was undertaken before the presidential election and that uncertainty over future French economic policy could have only added to the uncertainties generated by the economic cycle.

A lack of skills on the part of job seekers came in second place. Over a quarter (27%) of businesses looking to hire staff could not find people with the required qualifications. Although this constitutes a significant challenge, it is also a great opportunity for a cabinet that has put education and vocational training at the heart of its reform programme ! The difficulty is that promoting qualifications in the labour force is a long-term goal, which requires reforms of both initial education and lifelong learning, as well as committing resources that will not generate much in the way of short-term results. Yet another reason to set to work on the issue without delay !

In third place came labour costs (with excessive payroll taxes and wages being cited by 18% and 7% of respondents, respectively). If all difficulties related to costs are combined, including costs of hiring and firing staff, Insee reached a total of 23% of businesses (weighted by the size of their own workforces) reporting issues, whereas 18% expressed concerns about “regulatory barriers”.

It is possible to take an alternative view : the level of the minimum wage and the cost of firing staff are undoubtedly linked to the regulation of the labour market. Moreover, the fact that the cost of labour (wages and payroll taxes) is an impediment to hiring once again reflects the structure of the French labour market, where, because of rigidities, unit labour costs have increased faster than productivity for the last fifteen years, despite mass unemployment.

As such, barriers related to costs and regulation must be viewed holistically to assess the extent to which rigidity in the French labour market acts as a deterrent to recruitment. The bottom line of the Insee survey, therefore, is that a total of 41% of surveyed businesses(2) are reluctant to hire staff because of labour market rigidities. It is thus by far the most significant factor inhibiting recruitment, and this drag on business activity will only increase as the economy grows faster.

Given that the conclusion is reached by those who create jobs – companies themselves – the diagnosis justifies PM Edouard Philippe’s tight timescale for reforming the labour market, and therefore using ministerial decrees (“ordonnances”). The reform must address all rigidities within the labour market, and not limit itself to reforming the Labour Code. The level of the minimum wage is one of those rigidities, and it will indeed have to be tackled one day, for instance by reducing it without reducing income for employees at the bottom of the wage scale, by simplifying and enhancing the French version of the earned income tax credit (employment premium), so that it becomes a full-fledged negative income tax, visible on payslips.

4. Embrace a neutral fiscal policy to support reforms

The economic barrier to structural reforms is well-known : reforming the labour market as well as goods and services markets is unlikely to generate short-term results. In the first instance, if the aim of the reform is to make the labour market more flexible, and therefore making it cheaper and easier to lay off employees, it could have a short-term cost in terms of jobs. Even though short-term costs will be largely offset by future outcomes – comparing unemployment rates in Germany (3.9%) and France (9.5%) is enough to make this point – short-term costs might derail the entire reform programme by providing its opponents with arguments and even discouraging its proponents. Therefore, the ideal solution would be to combine an ambitious labour market reform with an expansionary fiscal policy so that the net effect on growth and employment remains positive.

The objection to this strategy is every bit as well known : as a candidate, Emmanuel Macron had committed to reducing France’s structural deficit in line with the commitments made to our euro area partners, and to do so from 2017 onwards, for obvious reasons linked to his own credibility. The Prime Minister should, therefore, commit to this approach in drawing up the budgets (State and social protection) for 2018. How can he achieve his goals'

First and foremost, an improvement of the economy should help keep the general government budget deficit to around 3% this year, as GDP growth should be stronger than anticipated in the budget (1.5% in the 2017 budget bill). For example, the budget balance was built on assumptions such as export market growth at 3.6%, whereas Insee now anticipates a growth rate of nearly 6%. Will growth be sufficient to fund all the spending spree of the previous cabinet, including a host of category-based pay increases in the civil service, without seeking for additional funding ? The Court of Audit has taken a harsh line in this respect, indicating that “expenditure clearly appears to have been severely underestimated, primarily for central government”, and estimating that expenditure could exceed the figures in the stability programme by up to €7 billion, or 0.3% of GDP. The Court came to the conclusion that the general government budget shortfall in 2017 should be around 3.2% of GDP. Even though the Court is conservative in its assessment of future tax receipts, it is by no means warranted that the deficit can be held below 3%, as France has committed to achieve. If it is necessary to make marginal adjustments to remain on track this year, it should be by cutting very cautiously government spending, not by increasing taxes, as was done at the onset of the previous five-year presidential term, following a major error about the importance of fiscal multipliers .

For 2018, it would be wise to aim for a neutral fiscal policy: namely, not seeking to reduce ex-ante the structural deficit, in order to support the reformist agenda. This approach assumes that labour market reforms will be implemented from this autumn onwards, so that France can convince its partners (and particularly – but not exclusively – the Germans) that France is eventually serious about labour market reform and that it would be counterproductive to force it into a countercyclical fiscal policy. Arguments against this strategy are well known : it is better to screw the budget at the start of the term, to leave room for manoeuvre later on, when the political capital of newly elected politicians starts to wear thin. Ensuring the success of the reforms is a sufficient reason not to adopt this way of thinking. As Emmanuel Macron has often indicated, failure to reform in France could sound the death knell for Europe itself, reviving nationalist and protectionist dynamics that the positive hopes his election generated has contained, at least for the moment.

(1)Chinese foreign currency reserves have fallen from 4 trillion dollars in early 2014 to a little over 3 trillion in June 2017.

(2)More precisely, 41% of employees are in businesses that assess that their hiring practices have been dampened by this labour market rigidity, because responses to the INSEE Survey are weighted by the size of polled companies.

(3)The argument put forward in 2012, including on the benches of parliament, was that cutting government spending leads to a greater level of economic contraction than an equivalent rise in taxation. It was based on multipliers that were estimated using figures gathered over a long period of time, during which public sector expenditure was close to 50% of GDP. At 57% of GDP, the extrapolation of these estimates should be called into question.