- Paul Masson
- Published Date:
- October 1995
© 1995 International Monetary Fund
Book design and production by IMF Graphics Section
Library of Congress Cataloging-in-Publication Data
France, financial and real sector issues / edited by Paul R. Masson.
Includes bilbiographical references.
1. France—Economic policy—1981 2. Finance, Public—France.
I. Masson, Paul R.
Please send orders to:
International Monetary Fund, Publication Services
700 19th Street, N.W., Washington, D.C. 20431 U.S.A.
Tel.: (202) 623-7430 Telefax: (202) 623-7201
Jonathan D. Ostry and Joaquim Levy
Marcel Cassard, Timothy Lane, and Paul R. Masson
The work undertaken here was the result of a joint effort of the mission teams working on France, and the authors of these studies are grateful for the advice and encouragement of their colleagues. First and foremost, thanks are due to Massimo Russo, Director of the European I Department, who influenced the topics undertaken, headed the missions to France in 1993-94, and supported the initiative of publishing these studies in a book. Michael Deppler also had many useful comments in the light of his past responsibility for work on France. Claude Bismut contributed to these studies with numerous comments and suggestions, as did various officials in Paris. However, the analysis reported here is the responsibility of the authors themselves, and does not necessarily represent the views of the Fund or other official institutions. Simon Willson of the External Relations Department of the IMF edited the manuscript for publication and coordinated production.
We are also grateful to Aline Clark, Nahid Mejib, and Rosalind Oliver for their conscientious and good-natured preparation of the texts, and to Susan Becker and Kote Nikoi for statistical assistance.
Paul R. Masson
France has undergone major transformations over the past decade. The French economy, formerly plagued by persistent inflation and frequent devaluations, has achieved a degree of price and exchange rate stability similar to Germany’s. The past decade has, in general, also been characterized by a return to fiscal rectitude in France, after the expansionary policies of the early 1980s. However, the recent recession has highlighted some severe structural problems. Most seriously, the unemployment rate has risen to levels that were previously unknown in postwar France. Moreover, the decline in real growth from the abnormally high levels of the late 1980s revealed serious fiscal imbalances that go beyond merely cyclical deficits.
Clearly, France faces major challenges as it enters the second half of this decade. One is the integration of the French economy with those of its European Union (EU) neighbors. To some extent, it is appropriate to see this as a continuation of a long-term trend that began soon after the Second World War with the formation of the European Payments Union and the European Coal and Steel Community, and the subsequent signing of the Treaty of Rome. However, it must also be recognized that the next major step envisaged, full economic and monetary union (EMU), would represent a dramatic break with the existing regime, in which EU members retain primary control over the levers of macroeconomic policy. A successful transition to a European monetary policy will require that the economies of the member countries develop increased flexibility to substitute for the ability to run a national monetary policy—notwithstanding the fact that this degree of freedom has not always been used to good effect.
The need for structural changes to enhance the economy’s flexibility is made more pressing by not only the starting point of high unemployment, but also by constraints on the possibility of providing further subsidies or tax incentives for employment. The situation of the public finances—a general government deficit equal to 6 percent of GDP in 1994, and a debt-to-GDP ratio that, though lower than in many of France’s partners, has risen alarmingly in recent years—precludes measures that would further widen the deficit. This is especially so given the context of the Maastricht Treaty: to qualify for EMU, a country must reduce its deficit below 3 percent of GDP (barring exceptional circumstances) and keep it under that ceiling thereafter. From a medium- to long-term perspective, moreover, there are worrisome tendencies related to demographic trends that will tend to widen deficits, especially those of the social security accounts.
Unemployment is the most serious symptom of France’s structural problems. It is clear that the high level of social charges provides a disincentive to hiring workers, especially at low skill levels. It is also widely accepted among economists that the relatively high minimum wage discourages hiring of some workers. To some extent, the French Government has begun to replace social charges on labor income with a broader tax on all incomes. However, the scope for reducing the tax wedge on labor income is constrained by the fact that labor income is such a large fraction of national income, and because capital, being mobile, is difficult to tax. Given budgetary constraints, France will therefore have to build a consensus in favor of addressing structural problems by reducing social benefits and cutting back on government expenditures generally, while at the same time creating room for maneuver to reduce tax disincentives. As for the minimum wage, an attempt to reduce it for younger workers ran into widespread opposition, and this issue has become highly politicized.
The chapters that follow attempt to shed some light on these policy challenges. They were prepared as background for the 1993 and 1994 Article IV consultations with France, and have not been updated with the most recent data. However, the issues considered are still important to French policy, and the analysis contained in the studies remains valid.
* * *
The first chapter, by Reza Moghadam, is an in-depth study of the causes of French unemployment and its possible remedies. The fact that unemployment has ratcheted up over the past decade, not falling much below 9 percent even in the boom years of 1988-89, argues that high unemployment in France is a structural, not a cyclical, phenomenon. Moghadam presents evidence on the contributions of French employers to social charges—which constitute part of the tax wedge making the cost to the employer greater than the employee’s remuneration; these are very high, even compared with other European countries. Empirical relationships linking long-run or structural unemployment to the employers’ tax wedge and the real value of the minimum wage are presented. Moghadam concludes that these factors must be addressed in order to achieve a durable solution to France’s unemployment problem.
The second chapter, by Jonathan Ostry and Joaquim Levy, attempts to explain trends in household saving; as a ratio to disposable income, it exhibited a steady decline over the 1980s, and then rose by 4 percentage points, reaching 14 percent in 1993. Since weak consumer demand was one of the causes of the 1993 recession, discovering its causes was important to assess the prospects for recovery. From a longer-term perspective, household saving provides a large source of funds for domestic investment, and hence will influence the economy’s ability to invest profitably without resort to foreign saving.
The authors first examine whether the fall in consumption in the early 1990s reflected precautionary saving resulting from the greater perceived riskiness of future income. While they find some evidence that the variance of innovations to income affects saving, the impact is much smaller than the traditional effect of expected future income. The authors proceed to test a broader set of explanations of saving behavior. The most striking finding is the important role of financial deregulation during the 1980s, which encouraged household borrowing. The authors also conclude that the positive response of saving to interest rate increases has been permanently enhanced as a result.
The interest elasticity of investment is the subject of the next chapter, by Mark Taylor. In France, researchers have long found it difficult to identify any separate effect of interest rates on the level of investment, which seemed to follow changes in income as predicted by the accelerator model of investment. Such a result was justified by appeal to a zero elasticity of substitution between the factors of production, which would leave no room for relative factor prices (the ratio of wages to the cost of capital) to affect employment or investment. Not only is a zero elasticity in sharp contrast with estimates for other countries, it also throws into question the linkages through which monetary policy affects the real economy and the virtues of wage restraint in stimulating employment.
It is therefore reassuring that, using modern econometric techniques, Taylor finds a statistically significant and economically important effect of expected future real short-term interest rates on business investment (through their effect on relative factor prices). Moreover, these results suggest that an important part of the slowdown of activity in 1992-93 can be attributed to high real interest rates in Europe. Indeed, gross fixed capital formation in France declined in each of the three years 1991-93, by a cumulative 15 percent.
The existing regime, with the objective of maintaining the French franc within the exchange rate mechanism (ERM) margins of fluctuation (now widened to 15 percent) has at times strongly constrained the room for maneuver of French monetary policy. Not only was France obliged to match German interest rates, but, at times of strong speculative pressure—September-November 1992 and January-March 1993—French short-term rates were raised far above German rates in order to defend the franc. These episodes illustrate the pitfalls of an incompletely credible pegged exchange rate arrangement and the advantage of full monetary union where fears of exchange rate realignment would be absent. The next study, by Marcel Cassard, Timothy Lane, and Paul Masson, explores ways of facilitating a smooth transition to monetary union, and, in particular, the use that could be made of a cross-country monetary aggregate. The authors point out that, given the extent of integration of financial markets that already exists among a core group of ERM countries, it is possible that shifts between currencies would lead to national demands for money being unstable. In contrast, an aggregate of those countries’ money supplies might have a more stable demand function. This result seems to emerge from the data on the basis of their econometric estimates; it might therefore be desirable to give increasing weight to a core-ERM monetary aggregate, relative to purely national money targets. Two other arguments reinforce this recommendation: if implemented in the anchor country (Germany) it would represent a more European approach to monetary policy, consistent with the eventual goal of monetary union, under which policy would be guided by monetary conditions in all member countries. Empirical evidence in the form of causality tests also suggests that core-ERM money is a better predictor of German prices in the post-1983 period than German M3 alone, suggesting that greater attention to a core-ERM monetary aggregate would also be in Germany’s narrow interest.
The next study, by Gary O’Callaghan, considers how tax policy affects the allocation of saving and investment. In particular, he examines how differences in the taxation of various instruments in France can lead to distortions favoring one type of investment over another—often for no good economic reason. Indeed, changes to taxation in this area have often involved correcting inequities by creating a new tax-favored instrument, which then creates distortions of its own. The author argues convincingly that a level playing field in which similar instruments are taxed in the same way would increase economic efficiency.
A significant feature of the French financial system is the tax advantage granted to insurance policies, which are an important vehicle for saving. In contrast, there is little saving in the form of private (prefunded) pensions, which are very prominent in several other countries, such as the United States and the United Kingdom. Interest in private pensions has increased with the widespread recognition that the public pension system, which is financed on a pay-as-you-go basis, will not be able to maintain generous benefit levels without very large increases in contribution rates, given that in France, as in many other industrial countries, the average age of the population is projected to rise dramatically in coming decades.
The final paper, by Joaquim Levy, considers how private pensions could be encouraged, what form they might take, and what their effect might be in stimulating the development of the French financial system. Though private pensions cannot make up for the fact that the public system is unfunded, the author argues that a transition to a system with both public pensions (somewhat reduced in generosity) and funded private pensions might minimize the welfare losses associated with the higher contributions that will be needed. Moreover, these pension plans could be managed by existing financial institutions, on the model of those in the United Kingdom or the United States, rather than involving book entries by the companies themselves, as in the German model. The resulting pool of capital might favor private ownership of France’s enterprises and permit a more competitive business environment.
* * *
In conclusion, the studies in this book treat issues of central concern to the French economy’s prospects until the end of the century and beyond. They are presented in the hope that they will add to the fund of economic knowledge and contribute to an informed debate of the policy issues.