Can Anyone Fix France?

As an aimless teenager, Lionel Basset was shunted into a French metalworking school. He found it monumentally boring and dropped out at age 17. Now 21, he has worked just a few weeks at odd jobs since then. Most days, Basset hangs out in cafes with unemployed friends or roams the streets of Saint-Denis, a grimy Paris suburb where he lives with his cleaning-lady mother. He is angry. "I was very badly guided in school," he says, leaning against a graffiti-covered wall. "Nobody in France cares about the young."

On Apr. 23, Basset left his street haunts to vote in the first round of France's presidential elections. His candidate: Socialist Lionel Jospin--"the only one who might change things," he says. Underdog Jospin stunned pollsters by coming in first among nine candidates, ahead of the favored Gaullist conservative, Jacques Chirac. Yet Basset will probably not see Jospin in the presidential palace. Four conservative candidates jointly won 60% of the vote. So barring an upset--always possible in a campaign that's been full of surprises--second-place Chirac should win a May 7 runoff to succeed Socialist President Franois Mitterrand.

SOCIALIST YEARNING. Chirac--or Jospin--will be taking the reins at a critical moment for France and for Europe. After 14 years under Mitterrand, France has lost its way. It is tormented by political and business scandals. State deficits have soared. The French can't decide what shape they want for a united Europe. Worst of all, an economy that in many ways is among Europe's strongest cannot create enough jobs. Unemployment of 12.3%, and an alarming 25% for those under age 25, is a time bomb.

The May departure of the 78-year-old Mitterrand--the Western world's longest-ruling leader--is a crucial turning point. It's potentially as momentous for France as the 1958 return of Charles de Gaulle to save France from upheaval in Algeria. This time, the issue isn't the collapse of the empire. It's the bankruptcy of old economic and political ideologies in France--and the worrisome vacuum left behind.

The crisis encompasses left and right. Mitterrand put France through a Marxist experiment, playing out the nation's ancient socialist yearning. He nationalized banks and industrial companies and sharply boosted social benefits. The experiment flopped. French Socialists backtracked, and now they're leaving behind a mushy "mixed" system driven by neither Marx nor markets. Meanwhile, the conservatives, heirs to the discredited elitist statism associated with Louis XIV's Finance Minister, Jean-Baptiste Colbert, also seem uncertain of what they stand for.

Many economists and business leaders know what France needs: a drastic overhaul of inflexible labor laws, an end to government control of large corporations, a vibrant private pension system, and a taming of a free-spending state sector that, in the words of economist Christian Saint-Etienne, has become a "monster, a national catastrophe." Yet if France's new leader can't implement radical measures, his seven-year term may mark a dramatic decline in the proud country's economic status and in its influence in the world. So the new President must greatly speed France's economic modernization, which began a decade ago with industrial restructuring and a halting movement toward free markets.

New leadership in France also spells a turning point for Europe. At stake is the prospect for a tighter European economic and political union. Under Mitterrand, the French became a prime force in the move toward European unity. Many French, however, are having second thoughts, as fears grow that Germany would dominate a united Europe.

DOMESTIC WOES. While Jospin would continue Mitterrand's pro-Europe policy, Chirac has waffled on the Europe question. Many of his fellow Gaullists are die-hard nationalists who don't want to give up sovereignty--monetary or otherwise--and who reject Germany's federalist urge. A political chameleon making his third run for President, Chirac might move France closer to Britain's Euroskeptics, as Europe gears up for a crucial 1996 conference on the union's future.

Even if they don't switch course on Europe, Chirac and Jospin are proposing remedies for domestic woes that could still hurt chances for unity. In a populist pose, Chirac claims to be the "candidate of change" who would attack unemployment. To encourage hiring, he proposes a cut in employers' onerous payroll taxes. Most agree this is a good idea. But it would cost the government badly needed revenue, and Chirac has not proposed any spending cuts to compensate.

For his part, Jospin is an outright interventionist. A traditional Socialist and advocate of government action, he wants a halt in the privatizations that have spun off billions in government assets to investors. He envisions a massive public-works program to soak up unemployed workers, and he estimates that a two-hour cut in the workweek, to 37 hours, would add 400,000 jobs to the economy.

Many investors fear either approach would lead to higher deficits and a weaker franc. That would be a huge setback after eight years of hard-won monetary stability and high interest rates that have lowered inflation to under 2%. France's deficit still reached 5.6% of gross domestic product last year, almost twice the German level and far above the 3% limit required for European monetary union by decade's end. A French failure to qualify for monetary union could kill a single European currency and be a major reversal for tighter European union in general.

Such concerns led traders to hammer down the franc in late April. In response, Chirac vowed allegiance to le franc fort--a strong franc. Yet there are doubters. A weaker franc is inevitable, says Steven H. Nagourney, chief global strategist for Lehman Brothers Inc. "If the new President doesn't devalue," he says, "the market will do it for him." The day after Jospin's first-round win, traders briefly drove the franc close to its historic lows against the mark. Bundesbank watchers think a weaker franc will pose a dilemma in Germany, which is already suffering from a too-strong mark. "I see a possibility for conflict between German and French monetary policy," says Joachim Fels, economist at Goldman, Sachs & Co. in Frankfurt.

While worrying about the markets' reaction, the new President faces the prospect of social unrest if he takes the necessary, painful steps. The social makeover France needs includes major cuts in cherished benefits. With national health care picking up the tab, the French pop more pills per capita than any other Europeans, while doctors send patients to seawater-therapy spas for rest cures. Workers also fiercely defend high pensions, which reach 75% of final pay for males retiring at 60.

Likewise, France's population of homeless and long-term unemployed--dubbed les exclus--could become an explosive political force. Like Lionel Basset, many are young and live in working-class ghettos on the fringes of Paris. The ruling classes wonder how long it will be until les exclus vent their rage.

Bernard-Henri Levy is among those who fear social upheaval. A handsome philosopher with Byronic locks, Levy is the current archetype of that lofty French hero, l'intellectuel. In his opulent Left Bank apartment crammed with Asian antiques, Levy warns that a street revolt would be far nastier than the 1968 uprising of affluent students. "Marxism," he says, "was the last hope for les exclus in France." Socialism's "shipwreck" has buried all hope for them, he says, increasing their desperation and penchant for violence.

Plenty of French industrialists counter that excessive state regulation has actually locked the unemployed out of the job market. "There are too many rules in France," complains Peugeot Chairman Jacques Calvet in his small, sober office near the Arc de Triomphe. Rigid labor regulation is a clear cause of unemployment, he says.

Take tiremaker Michelin. It's trying to boost output of truck tires because of strong European demand. But it's stymied by a ban on running French factories more than five days a week. After a long effort, Michelin has won government permission to operate an automated plant nonstop--for one year. But its four conventional factories must close on weekends, to protect workers' leisure. Michelin is a French success story, the world's largest tiremaker. But its profit margins of 2% trail those of its major rival, Goodyear Tire & Rubber Co., which has 5% margins.

FOOLISH STAKES. The intrusive state power that hobbles Michelin and other companies is wielded not just by politicians but by a corps of elite bureaucrats who run many top companies and help make France Inc. march to official tunes. This tradition saddles industry with inexperienced managers. And it has built an above-the-law caste prone to corruption--witness the dozens of bribery and political financing cases that crusading judges have unearthed over the past year.

Mercifully for France, this elitist system is cracking. The biggest fissure came from the recent $27 billion bailout of state-owned Credit Lyonnais. Europe's biggest bank almost collapsed after taking foolish stakes in French companies at government behest and making risky loans that smacked of political favoritism. Andre Levy-Lang, management board chairman of Compagnie Financire de Paribas says this debacle has knocked the technocrats off their pedestal: "These errors have won us 10 years in changing mind-sets." A big Lyonnais rival, Societe Generale, is fighting in Brussels to block the French government's bailout. That's an astonishing move in France's old-boy culture.

Credit Lyonnais and other scandals are introducing France at last to le corporate governance. Lyonnaise Des Eaux Dumez, a big water and construction company, has unveiled a strict ethics code to block payoffs. Paribas has named shareholder advocate Colette Neuville to its board. Directors of Alcatel Alsthom are likely to boost their oversight role, now that its deposed chairman, Pierre Suard, stands accused of fraudulent billing and personal use of company funds. "Governance is going to spread fast," says Neuville. "The scandals will have a major impact on how companies are run."

It will take more than a few independent boards to fix France, however. The nation's interventionist rulers can't quite bring themselves to set business free. Even though dozens of companies are being privatized, the state clings to minority stakes, "golden shares" that carry veto power, and cabals of institutional shareholders to influence policy and prevent takeovers. That's not a recipe for competitiveness in global markets.

COLD BATH. France also remains Europe's champion protectionist. Even Italy, which has resisted opening markets, is deregulating telecommunications faster. Air France Chairman Christian Blanc says he is "in favor of competition, as long as it's controlled competition." Such sentiments postpone the cold bath of cost-cutting that French companies need. Subsidized Air France has lost market share to more efficient rivals. It may end up as a modest regional airline, after losing more than $3 billion since 1990.

Former Prime Minister Raymond Barre says the French penchant for postponing the inevitable reminds him of a famous countess waiting at the Revolutionary guillotine. She implored her executioner: "Please, monsieur, just one more minute." Yet in some French business circles, at least, there's a growing consensus to let the knife fall. Jean-Louis Beffa, chairman of one of France's most prestigious private-sector companies, glassmaker Saint-Gobain, defends some subsidies--notably to Airbus Industrie and the Arianespace rocket program. But it's "very shocking," says Beffa, that state funds "have produced no results" at such tax sinkholes as computer maker Groupe Bull and Air France.

France's taxpayers learned just how shocking last month. State-owned Bull is finally being privatized, starting with minority stakes being sold to Motorola Inc. and Japan's NEC Corp. After dumping nearly $5 billion into Bull over the past 12 years, the French government has pegged the company's value at a mere $265 million. Le Monde said the valuation "marks the failure" of French computer policy.

The irony is that poll after poll shows an overwhelming popular urge for more state involvement in the economy, not less. Counting on government is a French habit that will be hard to break. An aide to Prime Minister Edouard Balladur insists that his government wanted to liberalize the economy, "but public opinion was against us."

THE WORST PARTS. It's not clear whether either Chirac or Jospin has the will to brave public disapproval and strive for deep structural change. Chirac should at least have the opportunity. He would be Europe's most powerful politician, with an 80% conservative majority in Parliament. His likely Prime Minister, Foreign Minister Alain Juppe, is widely respected for his pragmatic intelligence.

If Chirac and Juppe figure out a way to dismantle the worst parts of French statism, France could experience an industrial renaissance. Beneath its problems, the world's fourth-largest economy has a lot going for it. It has Europe's lowest inflation, good productivity, a positive trade balance after 15 years in the red, and lower labor costs than Germany. Mercedes-Benz recently picked France over Germany for its newest car factory. "I believe very much in French productivity and reliability," says Mercedes CEO Helmut Werner. Investment strategists at Morgan Stanley & Co. in London say France's economic fundamentals are "better than Germany's."

Those strengths flow from a massive industrial restructuring in the 1980s, when the French rightly feared that competition in Europe's single market could destroy them. Companies automated factories, and the government allowed big layoffs for the first time. For a while, French output per capita soared above German levels (chart, page 46). Renault's biggest plant now makes the same number of automobiles with 8,302 employees as it took 22,700 workers to build 20 years ago.

FRAGILE SIDE. French companies have made big strides bridging another gap: poor global reach. Billion-dollar U.S. acquisitions have been made by Pechiney, Rhone-Poulenc, Thomson, Michelin, Saint-Gobain, and Usinor-Sacilor. Renault and Peugeot are building car plants in China, while Danone (formerly BSN) is snapping up food companies around Asia, and retailer Carrefour is opening stores in Latin America. France's 50 biggest companies now get more than half their sales outside France. An annual World Economic Forum study ranks France's economy as the world's third most international, after the U.S. and Germany. In 1991, France was 17th.

Yet there's a fragile side to this success. More of France's export success has been in Europe than in tougher global markets. Its forte is commodity products--aluminum, steel, cement, glass--rather than high value-added items. That's why Germany, with its precision instruments and machinery, has coped better than France against devalued currencies in Britain, Italy, and Spain. Moreover, France's industrial makeover has slowed, while German industry has discovered restructuring in a big way and may leapfrog the French.

French weakness in high tech is another worry. It flows partly from a shortage of entrepreneurs, and therefore of midsize companies along the lines of Germany's Mittelstand. Critics fault cerebral French education for putting Proust above profit. Another cause is the lack of private pension funds, which in the U.S. have provided billions in equity capital for established companies and startups.

Such funds could also plug deficits in the posh state retirement system. But politicians have dithered over launching them because pensioners fear being abandoned by the government. "It's a scandal that Balladur didn't start them," says economist Saint-Etienne, who hopes Balladur's successor will.

The biggest French failing, however, is unemployment. "Without that, everything else would be fine," says Beffa of Saint-Gobain. Joblessness alienates the young, and it undermines the already weak social security system, which must support a graying France. Even with a recovery gathering steam, unemployment is expected to drop only to 11% or so next year.

Deregulating the process of hiring and firing could do wonders to create jobs. "The difficulty eliminating jobs makes you hesitate to hire," says Peugeot's Calvet. A company that wants to cut its workforce usually needs government permission and must give around 18 months' pay. Water-bottler Perrier tried to cut 600 jobs recently to boost efficiency. Bureaucrats said non.

CRAVINGS. It's not surprising how French companies have dealt with this straitjacket: Instead of hiring, they've imported machines from Germany. Automation partly explains the rise in French productivity. Yet much of the payoff goes to care for the unemployed. Meanwhile, even the French who have jobs are threatening strikes as they demand a share of rising corporate profits.

France made an important decision in the 1980s: to open its economic borders to Europe and the world. So far, however, the French can't quite accept the ramifications of that move. In a global economy that is decidedly capitalist, France still craves the comfort of a provident state. The French are also having serious second thoughts about their historic push for European union--even though it offers the surest harness to rein in their mighty German rival.

France certainly needs a quick fix, to help its jobless rolls start shrinking faster. Chirac's prescription of lower social taxes is probably a good one. But beyond that, the new leader needs to launch a deep overhaul of France's outdated economic approach. With luck, the disillusioned youths at the gates of Paris will allow him time to do that.



UNEMPLOYMENT. Now 12.3%, it stays high even in boom times. It has dipped below 9% only briefly in a decade. The young jobless are a social powder keg.

STATE SPENDING. It's out of control, especially for health care and retirement. The health system will be bankrupt by 2010. France has too high a deficit to join the European currency plan.

BIG GOVERNMENT. State economic involvement stifles initiative, spawns corruption, scares foreign investors, and wastes resources. Protectionism hurts industrial efficiency and hampers innovation.

INDUSTRY WEAK SPOTS. The stress is on "commodity" products--steel, aluminum, basic chemicals. A weakness in high-tech businesses is worrisome for the future. Entrepreneurs are rare.

INBRED LEADERSHIP. An elitist management culture lacking independent oversight breeds corruption, as well as business disasters such as the vast losses at Credit Lyonnais, Groupe Bull, and Air France.


MAKE IT EASY TO HIRE. Social levies on employers must be cut. More flexible labor rules would encourage hiring. Schools should put job skills ahead of Voltaire and Descartes.

CHANGE THE RULES ON RETIREMENT. Retirement at age 60 must no longer be encouraged.Private pension funds should take over part of the retirement system. Health-care largesse must shrink.

GET GOVERNMENT OUT OF BUSINESS. Total privatization is essential--without the minority government stakes and "golden shares" common so far. Politicians should commit to deregulation.

BOOST INVESTMENT. Market forces, not bureaucrats, should direct resources into industry. The creation of private pension funds would increase equity capital for companies and entrepreneurs.

CREATE REAL CORPORATE BOARDS. Boards should be dominated by genuine outsiders. CEOs should come from inside, not government. Audit committees should be formed of outside directors.