President Nicolas Sarkozy has been a key player in shaping Europe’s response to the debt crisis that has so far infected Greece, Ireland, and Portugal. Yet the most important thing he can do to shore up the euro may be to deal with the mounting economic problems in his own country. “On our current trajectory, we’re driving straight into the wall,” says Jacques Mistral, an economist at the Paris-based IFRI think tank and member of the French prime minister’s council of economic advisers. “There’s no room to maneuver.’’
Europe’s second-largest economy and contributor to the region’s bailout funds is among the euro zone’s laggards in cutting its own deficits. Though a traditionally strong exporter, it’s headed for a record trade deficit this year. France still has a AAA credit rating, and its national debt of €1.6 trillion ($2.3 trillion) is roughly on par with Germany’s. Yet at 7 percent of gross domestic product, France’s 2010 budget deficit was higher than Italy’s and double Germany’s in relative terms. Excluding those now receiving bailout funds, in the euro zone only Spain and Slovakia did worse.
French companies, which are big players in aerospace, chemicals, pharmaceuticals, farm products, and autos, are struggling to compete. The nation’s share of European exports has dropped to 12.5 percent in the first five months of this year, down from 15.6 percent in 2000, according to Coe-Rexecode, an economics consultancy that advises the French government.
France’s trade deficit was more than €7 billion in both April and May—bigger than in any previous month—and is on track to set a record for this year, according to Michel Martinez, an economist at Société Générale in Paris. Exports are below their pre-recession level and “the contrast with Germany, which has taken full advantage of the world recovery, could hardly be more striking,” says Martinez. Last year Germany posted a surplus equal to 5.3 percent of output.
Unlike Germany, France has not spent the last decade lowering social welfare expenses, cutting state spending, and urging wage restraint. Now France is stuck competing for customers against lower-cost rivals in Eastern Europe and East Asia, and competitors in Germany who make up for their high costs by being very productive.
“France has a real problem of competitiveness,” says Eric Chaney, chief economist for insurer AXA in Paris. “If you have competitiveness, you have growth, and the public finances then become very easy to fix. You enter into a virtuous cycle in terms of borrowing costs because markets prefer countries with growth prospects.” Of course, if you are not competitive, public finances become a mounting burden as companies make less profit and pay less tax, and bondholders demand higher yields to compensate them for the higher risk of holding your bonds.
The recent surge in borrowing costs for Italy shows how ready investors now are to pounce on any signs of economic weakness. The Italian fiasco also puts France one step closer to the front line of Europe’s debt crisis. “I worry it will actually move to France,” says David Blanchflower, a professor at Dartmouth College and former member of the Bank of England’s Monetary Policy Committee. The premium France pays over Germany to borrow for 10 years surged as high as 71 basis points on July 13 and now stands at 62 points.
Sarkozy, whose term ends in May, vows to honor his pledge to cut the budget deficit to 3 percent in 2013. Budget Minister Valérie Pécresse recently said that Sarkozy is even willing to raise taxes, something he swore he would not do. “We’ll keep this promise, and we’ll keep it whatever the economic circumstances, whatever the growth and inflation rates,” Pécresse said on July 17. “If necessary, we’re ready to find additional revenue.”
Even the opposition Socialists promise to improve public finances if they win next year’s election. “We have to balance the public accounts without delay,” said François Hollande, the leading contender to become the Socialist candidate for president, on the same day that Pécresse tried to reassure the markets.
Increasing taxes to lower the French deficit would risk driving away businesses, jobs, and taxable income, economists say. French government spending already amounted to 56 percent of GDP in 2010, higher than any other euro-zone nation except Ireland.
To tackle France’s twin deficits, Sarkozy has started easing labor laws, raising the retirement age, and investing in research and education. Yet he or his successor needs to go further and faster, notably by limiting increases in the minimum wage and reducing spending on health care and unemployment benefits, according to AXA’s Chaney and other economists.