2007 Article IV Consultation: Staff Report; Staff Supplement; Public Information Notice on the Executive Board Discussion; and Statement by the Executive Director for France

France’s near–term economic outlook is moderately positive, but clouded by risks from the global environment. The government’s reformist intentions provide an historic opportunity to place France onto a sustained higher growth path with greater opportunities for all. Economic policy should address the root cause of faltering growth performance. Further goods and services market reforms will boost potential output and consumer welfare. Fiscal policy should be vigilant to the risk of slippage in the fiscal deficit. The ongoing expenditure and tax policy reviews have been commended.


France’s near–term economic outlook is moderately positive, but clouded by risks from the global environment. The government’s reformist intentions provide an historic opportunity to place France onto a sustained higher growth path with greater opportunities for all. Economic policy should address the root cause of faltering growth performance. Further goods and services market reforms will boost potential output and consumer welfare. Fiscal policy should be vigilant to the risk of slippage in the fiscal deficit. The ongoing expenditure and tax policy reviews have been commended.

I. Background

1. While reforms have advanced in recent years, France’s economic performance has remained comparatively weak. In its conclusions of the Article IV consultation last year, the Executive Board observed that France “has changed more than is commonly perceived,” but that “much remains to be done.” This continues to be the case. Reform progress has been gradual and piecemeal, growth has stalled below other major industrial economies, unemployment—though falling—has remained high, and export growth has been weak. A growing consensus has emerged that a more aggressive reform strategy is required to move the country onto a higher growth path—a consensus reflected in President Sarkozy’s explicitly reformist platform.

2. GDP growth has been modest due to supply–side weakness. GDP has risen by less than the euro area average for nine consecutive quarters (2005Q3–2007Q3), with France not participating in the revival of European growth since 2004, prompting political emphasis on a “growth deficit.” For 2007, growth is expected to be 1.9 percent, down from 2.0 percent in 2006 (Figure 1 and Table 1). Growth has been sustained by domestic demand, with the external sector persistently negative. The main contribution to growth has come from private consumption, reflecting steady increases in real disposable income. With domestic demand growth outstripping supply, imports have surged, with a net external drag on growth of some ½ percent of GDP per annum over the past five years.

Figure 1.
Figure 1.

France: Economic Developments 1/

(Percent change)

Citation: IMF Staff Country Reports 2008, 075; 10.5089/9781451813715.002.A001

Sources: Global Insight/DataInsight and IMF, WEO.1/2007 data are estimates.2/ Contribution to growth of GDP.
Table 1.

France: Main Economic Indicators, 2003–12

(Annual percentage change; unless otherwise indicated)

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Sources: Banque de France ; data provided by the authorities; and IMF staff estimates.

Data from the INSEE quarterly national accounts system.

Change as percentage of previous year’s GDP.

Harmonized CPI.

For 2007, year–on–year October.

In percent of labor force; harmonized index.

GDP over total employment.

Personal disposable income deflated by the implicit deflator for private consumption.

In percent of household disposable income.

In percent of potential GDP.

Index; Base 2000=100; for 2007, average to October.

In percent of GDP.

Maastricht definition.

Data for 2005 and 2006 exclude the EDF and La Poste pension fund transfers, respectively (0.5 percent and 0.1 percent of GDP).


Real GDP growth

(over same quarter of previous year)

Citation: IMF Staff Country Reports 2008, 075; 10.5089/9781451813715.002.A001

3.Export growth has slowed in recent years, heightening concerns about competitiveness. Real export growth has lagged behind the euro area average since 2003, generating a drop in market shares for French exports, both worldwide and within the EU and the euro area (Figure 2). With strong import growth, France’s current account balance has deteriorated from a surplus of 1.4 percent of GDP in 2002 to a projected deficit of 2.0 percent of GDP in 2007 (Table 2); current account and trade balances with the euro area have also deteriorated. 1 The ratio of exports to GDP has risen by 2 percentage points versus a surge in import penetration of 5.1 percentage points of GDP.

Figure 2.
Figure 2.

France: External Sector Developments

Citation: IMF Staff Country Reports 2008, 075; 10.5089/9781451813715.002.A001

Sources: IMF; DOT and WEO.
Table 2.

Balance of Payments

(Percent of GDP)

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Sources: IMF, WEO; and the authorities.

Staff estimates.

Table 3.

High Frequency Financial Indicators

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In Euro’s.

Basis points, 5 years.

Percent; and change in percentage points.

Basis points; 3 month interbank rate minus 3 month Treasury Bill..

Table 4.

France: Vulnerability Indicators, 2001–07

(In percent of GDP; unless otherwise indicated)

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Sources: Banque de France ; IMF, International Financial Statistics; Bloomberg; FNAIM; and Commission Bancaire.

This index combines the effect of real disposable income, repayment conditions for loans, real estate prices, and interest subsidies.


All credit institutions aggregated data on a parent–company basis.

Table 5.

France: General Government Accounts, 2000–07 1/

(In percent of GDP)

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Sources: INSEE; and IMF staff calculations.

Data for 2001–02 exclude the proceeds from the sale of UMTS licenses, which amount to about 0.1 percent of GDP. Annual national accounts.

Maastricht definition.

Data for 2005 exclude the EDF pension fund transfer (0.5 percent of GDP).


Real export growth


Citation: IMF Staff Country Reports 2008, 075; 10.5089/9781451813715.002.A001

4. While unemployment has declined, labor market performance remains weak(Figure 3). The (EU harmonized) unemployment rate has fallen 1 point over the past year (to 7.9 percent), mirroring the decline in the euro area (to 7.2 percent). However, unemployment remains stubbornly above the EU average and is particularly acute among younger workers (near 20 percent). At the same time, the employment rate is among the lowest in Europe. While employment creation has improved since 2004, it remains under 1 percent per year. Growth of the minimum wage (SMIC) has sharply outstripped general wages (and productivity), pricing many low–end workers out of the market.

Figure 3.
Figure 3.

France: Labor Market Indicators

Citation: IMF Staff Country Reports 2008, 075; 10.5089/9781451813715.002.A001

Sources: OECD; Datastream; and IMF staff calculations.

Real GDP and employment growth

(annual percent change)

Citation: IMF Staff Country Reports 2008, 075; 10.5089/9781451813715.002.A001

5.Inflation was muted through the summer, but has since spiked. Core inflation has edged up since early 2006, but remains at 1.7 percent, below the euro area average. Headline inflation fell sharply in 2006 and early 2007 to a 1.2 percent annual rate in August. Since then, however, the sharp increase in food and energy prices pushed headline inflation to 2.8 percent in December. Notable in the good performance of French inflation through the summer has been the role played by measures to liberalize product markets. The authorities estimate that laws easing restrictions on large stores and retail sales margins helped lower inflation by ½ percentage point since mid–2004, with most of this effect since 2006. Unit labor costs have been climbing, as productivity gains have lagged wage inflation. French labor costs rose 3.2 percent in the year to Q3 2007 (versus 2.5 percent for the euro area)


Headline and core inflation

(6 month moving average)

Citation: IMF Staff Country Reports 2008, 075; 10.5089/9781451813715.002.A001

6. Monetary conditions have tightened since 2006. The monetary conditions index (MCI) has moved sharply upward since early 2006, reflecting ECB tightening and, more recently, euro appreciation. Moreover, risk premia on lending have increased due to the fallout from the financial turbulence (Figure 4). While long–term interest rates have risen moderately, short–term rates have spiked in recent months. In contrast, the fiscal stance has eased.

Figure 4.
Figure 4.

France: Monetary Condition

Citation: IMF Staff Country Reports 2008, 075; 10.5089/9781451813715.002.A001

Sources: Datastream/Thomson Financial; European Comission; and IMF, IFS and WEO.1/ The monetary conditions index is a weighted average of the real effective exchange rate and the short–term real interest rate, with weights, 1 and 2.5, respectively. A higher index implies tighter conditions (using underlying CPI).

II. Outlook

7. Financial turbulence has had little impact on the domestic economy to date, with limited effects on French banks, but global spillovers stand to dampen growth. Banks’ performance has continued to be solid, and exposure to the U.S. subprime market appears limited. Credit default swap spreads have risen, but somewhat less than for some other major European banks (Figure 5), and no bank has yet experienced the type of difficulties seen elsewhere. French banks are generally well–capitalized and there is no domestic subprime market as such. While real estate prices have risen markedly and may be somewhat overvalued, French households are much less indebted than their U.K. or U.S. counterparts, and the share of variable rate mortgages is low. This low leverage of French households may soften the impact of any weakening of the real estate market. Nevertheless, the turmoil is expected to dampen growth in 2008 via effects on partner country demand as well as generally tighter credit conditions. Lending standards have been tightened by French banks, but less so than elsewhere in the euro zone. 2 Tighter conditions in 2006–07 may also trim growth in 2008–09, given the lags in monetary transmission.

Figure 5.
Figure 5.

France: Financial Market Developments

Citation: IMF Staff Country Reports 2008, 075; 10.5089/9781451813715.002.A001

Source: Thomson Financial/Datastream.1/ AXA, BNP Paribas, Credit Agricole, and Societe Generale.

8. For 2008, staff forecasts growth of 1.6 percent, weaker than anticipated earlier and below official projections. 3 The spike in oil prices, the rise in the euro, and weakening economic prospects in partner countries will be a drag on growth, offsetting the stimulus from the 2007–08 tax cuts. 4 Domestic demand will continue to sustain output, with the external sector contributing negatively. Downside risks predominate, notably concerning the depth and persistence of the financial market turmoil and its effects on other advanced economies. On the upside, rapid reform progress could help sustain confidence and growth. The authorities maintain the budget forecast of growth of 2–21/2 percent for 2008. Core inflation is expected to remain around 11/2 -13/4 percent, but headline inflation may rise due to pressure on food and energy prices


Real GDP Growth: Risks to the Forecast

Citation: IMF Staff Country Reports 2008, 075; 10.5089/9781451813715.002.A001

The chart includes the following risks to the baseline projections of growth (1.9 percent in 2007 and 1.6 percent in 2008):• persistent tightening of financing conditions;• 10 percent euro appreciation;• 1 percent drop in foreign demand;• boost in domestic confidence reflecting steady progress in reform agenda;• a US recession and a disorderly unwinding of global imbalances.They are weighted by the staff’s subjective probability assessment of their occurrence.

9.The staff baseline for medium–term trend growth is just under 2.2 percent annually—close to the authorities’ 2.1 percent. Growth is forecast to remain somewhat below potential in 2009 due to the aftereffects of slower global growth and tighter monetary conditions. Thereafter, staff projects growth to accelerate, with scope for an increase in potential output growth through structural reform. Staff projects 1 percent total factor productivity growth annually in the medium term. Relatively high fertility, strong immigration, and lower mortality should attenuate the effects of aging of the labor force. Staff estimate that the incentive effects of reduced taxation on overtime and other measures of the 2007–08 fiscal package might marginally boost growth, but more far–reaching, simultaneous reforms could boost long–run GDP by much more—up to 10 percentage points over 10 years. 5

III. Policy Discussions

10.The government’s policy agenda is centered on implementing comprehensive structural reforms to generate higher growth, raising employment and purchasing power. Labor market reform is central to the government’s program, as is captured in the slogan “work more to earn more.” Key initiatives are also underway in product and services markets, as well as broad tax and expenditure reviews. Policy discussions centered on these initiatives, with staff stressing the need for ambitious efforts and a focus on the country’s supply deficiencies. The supply–side focus was prompted by some early (mainly demand–oriented) measures and the emphasis on increasing households’ purchasing power, where there is sharp political pressure for action. Fiscal policy was also central to the discussions, with differences of view over the perceived trade–off between fiscal adjustment and structural reforms, and the related “adjustment pause” in 2008, but full agreement on the importance of rethinking the state’s role in the economy in order to secure expenditure–based consolidation in the medium term.

A. France’s External Sector Weakness

11.Competitiveness—as measured by the real effective exchange rate—has deteriorated, but the appreciation fails to fully explain France’s poor export performance. France’s real effective exchange rate has risen by 4½ to 12 percent since 2002, depending on the deflator used—due to euro appreciation and to higher French labor cost growth (Figure 6, panel 1). Within the euro area, competitiveness deteriorated against Germany, but improved against other countries; on balance, it strengthened modestly. Wages have increased faster in France, only partially compensated by higher productivity growth (Figure 6, panel 5). According to CGER–based estimates, France’s competitiveness gap remains modest—in a range of 1 to 9 percent (Figure 6, panel 6)

Figure 6.
Figure 6.

France: Competitiveness and External Performance

Citation: IMF Staff Country Reports 2008, 075; 10.5089/9781451813715.002.A001

Sources: INSEE; IMF, IFS; Eurostat; and Haver.
Figure 7.
Figure 7.

France vs. Germany: Out of Synch ?

Citation: IMF Staff Country Reports 2008, 075; 10.5089/9781451813715.002.A001

Source: IMF, WEO, DOT, and IFS; and OECD; Economic Indicators.
Figure 8.
Figure 8.

Combining Fiscal Consolidation and Structural Reform–Canada

Citation: IMF Staff Country Reports 2008, 075; 10.5089/9781451813715.002.A001

Sources: OECD, Economic Outlook; and IMF, WEO.

Real Effective Exchange Rates

(ULC based, 2002=100)

Citation: IMF Staff Country Reports 2008, 075; 10.5089/9781451813715.002.A001

12.Broader structural factors underlie faltering export performance. A strengthening euro is no doubt increasingly challenging exporters, but staff viewed structural factors, including high wage increases, supply constraints, and insufficient flexibility in responding to changing global demand as more important constraints on export performance. The authorities acknowledged the structural rigidities, but also saw a widening cost gap chiefly with Germany as a key factor in weakening French export performance within the EU. 6 France’s sector specialization is also unfavorable—with export weakness concentrated in automobiles and small firms. 7 Consequently, strengthening the export capacity of SMEs and increasing investment in R&D were seen as major levers to further export performance in the medium run. While few workers in the export sector are at the minimum wage (SMIC), strong SMIC increases have contributed to wage pressure elsewhere, and have helped boost imports.

B. The Reform Agenda

13.The move to a more forceful reform stance raises several political economy considerations. The authorities have opted to pursue simultaneous reforms across a wide range of areas, breaking with the incrementalist approach of the past. Staff supported this strategy, noting that important synergies exist in contemporaneous action. Properly calibrated, simultaneous reforms—addressing rents in several areas—could help attenuate the political opposition of special interests. 8 A “critical mass” of reforms would also generate faster and larger payoffs in terms of growth, employment, productivity, and lower prices for consumers, thereby garnering consensus. However, staff and the authorities had different views about the interaction between fiscal adjustment and structural reforms. The authorities felt it important to fulfill campaign pledges and provide early tangible benefits to pave the way for reforms whose results take more time. It was in this light that they justified the government’s early tax reduction measures. These measures also addressed a key concern of the electorate—the perception of stagnant or declining real incomes (pouvoir d’achat). While acknowledging the political potency of these arguments, staff’s reading of the data suggests that French incomes have actually risen more than in other euro area countries (Box 1). Staff noted that the emphasis on purchasing power risked obfuscating the true nature of France’s growth difficulties—the weakness of its supply potential—while raising expectations that could not be met. More generally, staff viewed fiscal adjustment and structural reforms as complementary and thus considered the decision to pause fiscal consolidation in 2008 ill–advised.

Pouvoir d’Achat: Perception and Reality

In recent opinion polls, French consumers rank eroding purchasing power (pouvoir d’achat) as their greatest economic concern, above unemployment. Yet data show that over the past seven years, real disposable household income has increased in France faster (18 percent) than in the euro area (11 percent), and significantly faster than in most neighboring countries (panel 1). There is thus a wide disparity between a public perception and the national accounts data. 1 Reasons for this disparity may include:

  • Income per head has increased less than the aggregate due to population growth (0.6 percent).

  • While real wages per hour have risen, real wage incomes have stagnated since the 1980s largely due to adecline in paid hours worked.

  • Perceived inflation has been persistently higher than measured inflation since early 2001 (panel 2). Highly visible price increases (e.g for food) may have had a disproportionate impact on perceptions.

  • Strong increases in rents, which are weighted less in the consumer price index (6.1 percent) than in the national accounts (18.6 percent weight in private consumption, including imputed rents by owners).

  • A rising share of non–discretionary spending, such as for housing, financial services, and insurance. Down payments on housing loans, for example, are savings in the national accounts, but many private households regard them as reducing their purchasing power.

  • An unequal distribution of income, leaving certain households financially pressed. Income distribution data (available only through 2004) indicate that real incomes for the lowest and highest deciles of the population rose between 2002–04, but most other deciles were stagnant or declining, resulting in a middle class “squeeze.” As noted in the October 2007 WEO, however, “among the largest advanced economies, inequality appears to have declined only in France.”

Sources: European Commission, Ameco, and EC consumer survey.
1 J. Accardo and others (2007),La mesure du pouvoir d’achat et sa perception par les menages, in L’économie française, 2007. The statistical agency (INSEE) has been charged with elaborating new purchasing power data, and Nobel laureates Stiglitz and Sten have been asked to consider including “quality of life” factors in measuring growth.

Freeing the labor market

14. There was agreement that labor market rigidities are probably the single most significant barrier to higher economic growth and employment. France’s already low labor input declined further in recent years, reflecting both high unemployment and lower working hours among the employed. Main shortcomings in the labor market, as identified by the authorities and the OECD (Figure 3), are: (i) burdensome legal restrictions on hiring, firing, working hours, and functional mobility under permanent contracts, generating inefficiencies and a severe “insider–outsider” divide; (ii) pervasive judicial involvement in labor relations; (iii) inefficiencies and lack of coordination among public job placement and unemployment compensation agencies; (iv) a high minimum wage; and (v) one of the highest tax wedges on employment in the OECD. These distortions in turn weigh heavily on the public purse, as tax breaks attempt to compensate for the rigidity of labor market institutions.

15. The social partners have concluded a 4–month long negotiation on the reform of labor contracts. Changes in the labor framework include an increase in the trial period, a new labor contract that will allow project–linked employment and new incentives to end permanent contracts through amicable separation. Dismissed workers will carry with them rights to complementary health insurance, training and unemployment benefits that reflect the contributions they made while employed. While this agreement should allow increased use of temporary contracts and facilitate separations on permanent contracts, it falls short of a comprehensive reform. Staff noted that studies suggest that reforms making the labor market more flexible at the margin are ineffectual, tending to artificially increase the turnover rate and only modestly affecting job creation, while having potentially harmful effects on welfare. 9

16. The government is undertaking other initiatives to mitigate labor market distortions. The most important among these are a review of the mechanism for setting the SMIC, the merger of the unemployment and job placement agencies, and steps to impart greater flexibility to the 35–hour workweek arrangement. There was agreement that the secular rise of the SMIC has priced young and unskilled workers out of jobs and compressed wages at the bottom end, demotivating effort. To begin correcting these distortions, the government omitted the habitual discretionary increase of the SMIC in 2007 (the so–called coup de pouce), limiting the adjustment to that determined by the indexation formula (a combination of inflation and the increase in the average base salary). While staff saw drawbacks in the formula, it is unlikely to change. The authorities are leaning rather toward a U.K.–style “low pay commission” to provide technical input and de–politicize decisions. The merger of the job placement and unemployment agencies aims to promote a “return–to–work” orientation via a closer, one–stop guidance of job–seekers.

17. The authorities have attempted to make the 35–hour workweek less binding, without formally reversing what is viewed as a social acquis. 10 The main measure to date is the elimination of taxes and social charges on overtime work. While uncertain, estimates suggest that the measure would create relatively few new jobs, at a budget cost of about 0.3 percent of GDP. The authorities highlighted the signaling value of the measure in extolling work effort, providing greater flexibility, and reducing marginal wage costs, while not completely discounting staff criticisms of its shortcomings (windfall effects, operational complexity to avoid probable fraud, and further recourse to the budget to alleviate a distortion). More recently, the president has announced other possibilities to ease the workweek limit, including through majority agreements in individual companies in exchange for wage increases. These steps have met with a mixed reception, given their administrative complexity, especially for smaller firms.

Goods and services markets—raising competition and consumer welfare

18. Staff and the authorities agreed that further goods and services market reforms could significantly boost potential output, competitiveness, and consumer welfare. This emphasis is supported by studies showing that the benefits would be sizeable. 11 The authorities have assigned priority to early reforms in the retail distribution sector, while undertaking preparatory work for the implementation of the EU Services Directive. A careful review of all existing regulations is underway to ascertain their compatibility with the Directive’s provisions. There was agreement that action need not await the Directive’s drawn–out timetable, and could proceed in several areas—notably as regards regulations in retail distribution, hotels, and restaurants, and tightly controlled activities and professions (Box 2).

Key Product and Services Market Reforms

Several reform areas appear particularly promising in their ability to improve economic efficiency, yielding lower consumer prices and greater productivity:

  • Supplier–retailer relations. Heavy–handed regulations originally designed to protect against predatory pricing (codified in the loi Galland) have in practice strengthened the market power of large existing firms, resulting in higher consumer prices. Previous steps to contain prices on national branded products and the 2005/06 reform of the loi Galland yielded positive results. More recently, the government introduced legislation to free wholesale margins, passing savings fully on to consumers.

  • Retail space and openings. Legal entry barriers 1 have reduced new establishment of large retail shops, hotels, and restaurants by almost 60 percent and limited the share of “maxi–discounters” to 13 percent in France, compared to 30 percent in Germany. These barriers strengthen the bargaining position of large retailers against suppliers and protect incumbents from competition. The authorities also intend to ease regulations on retail opening hours and on sales periods.

  • Regulated activities and professions. Pervasive entry barriers include training requirements (certified accountants, notaries, lawyers, architects), licenses (taxi drivers), and restrictions on establishment (medical profession, pharmacies). Partly a result of self–regulation, entry barriers limit the supply of services, providing rents. Accordingly, there is significant scope for reforms, as recognized by earlier reports (e.g. Camdessus,2 and Cahuc and Kramarz 3). The latter includes a list of 75 regulated activities (métiers) and 28 regulated liberal professions.

1 The Lois Royer (1973) and Raffarin (1996) protect small retailers by subjecting the establishment of“grandes surfaces’’(above 300 m2)—including hotels—to special approval.2Le sursaut—Vers une nouvelle croissance pour la France, 2004.3 Cahuc, P. and F. Kramarz, De la précarité a la mobilité: Vers une securite sociale professionnelle, 2004.

19. Moving competition policy to center stage would, in staff’s view, be aided by a unified, independent, and reinforced competition authority. In line with both the OECD and the Attali Commission,12 staff advocated a change in France’s institutional framework for competition policy, modifying its dualistic setup (split between the Conseil de la Concurrence and a Directorate at the Ministry of Economy and Finance), including removing responsibility for merger control from the ministry—an arrangement at odds with international best practice. The authorities concurred that there was scope for greater advocacy vis–à–vis the public of the virtues of competition, but expressed doubts that the French institutional arrangement has compromised policy effectiveness. They pointed to the favorable ratings France has received in comparisons of national competition authorities, and questioned whether a unified authority was a genuinely superior arrangement.

C. Achieving Fiscal Sustainability

The fiscal position and objectives

20. After several years of fiscal adjustment, progress stalled in 2007. Between 2003 and 2006, the structural deficit fell by over 1½ percentage points of GDP, bringing the overall deficit to 2½ percent of GDP in 2006. However, higher revenues contributed most to the adjustment, with the share of general government outlays to GDP remaining broadly unchanged. Strong growth of social security and local government spending largely offset tight control of central government expenditures. This trend continued into 2007 due to slippages in health and pension–related spending. As a result, the general government deficit is estimated to have remained broadly unchanged in 2007 (at 2.4 percent of GDP), implying an underlying adjustment of only ¼ percentage point of GDP—half the SGP–recommended pace for countries and still distant from their medium–term objectives.

22. Despite continued spending restraint, the 2008 fiscal plans entail no underlying adjustment due to the costs of tax–reducing measures. On the positive side, real general government spending growth is limited to 1.4 percent, which would produce a 0.6 percentage point decline in the expenditure–to–GDP ratio (to a still high 52.6 percent of GDP). The budget also incorporates an unprecedented reduction in public employment (by 23,000); improves the coverage of the central government expenditure norm; limits the growth of transfers to local authorities; increases precautionary reserves; and contains further steps to enhance the co–responsibility of health care users and discourage early retirement. However, this expenditure restraint is largely undone by the cost of the tax package (½ percent of GDP). In addition to the tax exemption for overtime hours, the package includes tax credits for mortgage interest—viewed critically by staff due to its demand–side orientation with likely little impact on home ownership or economic growth (as demonstrated by international experience). 13 Indeed, France had removed this deduction in the mid–1990s. More positively, the 2008 budget includes a reformed research tax credit. The authorities project a general government deficit of 2.3 percent of GDP (based on GDP growth of 2¼ percent), resulting in an essentially unchanged structural balance and a marginal reduction in the public debt ratio (to 64 percent of GDP).

23. The 2008 budget appears subject to risks of slippage. The budget’s macroeconomic and revenue assumptions are optimistic, social security overruns remain a major risk (notably in health care), and expected efficiency gains in central government outlays could prove elusive. As a result, staff expects a structural balance deterioration of H percent of GDP and the overall deficit to reach 2.7 percent of GDP, close to the Maastricht limit (Text Table)—perilously so were downside risks to growth to materialize. 14 The authorities thought staff overstated the risks, and viewed the possibility of approaching the Maastricht limit as remote.

Text Table 1.

General Government Accounts 2006–12

(In percent of GDP; unless otherwise indicated)

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Sources: INSEE; IMF staff calculations; and 2008 Budget proposal.

Real growth (in percent) adjusted using CPI excluding tabacco prices.

Maastricht definition.

Excludes pension transfers and other one–off measures; assumes a tax revenue–to–GDP elasticity close to unity.

23. Views differed on the 2008 fiscal adjustment pause. The authorities considered the 2008 budget to contain positive pro–growth measures and other effects underestimated by staff, particularly in terms of generating goodwill for future, fundamental reforms. Staff, for its part, viewed fiscal consolidation and structural reforms as complementary and pressed that fiscal consolidation be restored as a national priority, as enshrined in last year’s budget documents and in the Pebereau Report on public debt. Experience in other industrial economies (such as Canada—see Box 3—and others15) has shown that contemporaneous fiscal consolidation and structural reforms can generate virtuous cycles of improved competitiveness, higher growth, and healthier public finances. Maintaining a steady pace of fiscal adjustment would promote credibility, eroded by the continuous postponement of the medium–term objective (Text Figure). Staff noted that an adjustment of ¾ percentage point of GDP per year in 2009–10 would bring the fiscal accounts close to balance by 2010.

Canada’s Experience: Combining Fiscal Consolidation and Structural Reform

Facing debilitating economic conditions, Canada launched path–breaking fiscal and structural reforms in the mid–1990s. During the 1980s and early 1990s, Canadians saw a marked deceleration in the growth of living standards combined with a chronic deterioration of public finances. Slowing productivity and employment growth led to sub–par economic performance while lax public spending contributed to further policy dislocation and spiraling debt dynamics (Figure 8). In 1994, the government set out a bold economic reform to strengthen Canada’s macroeconomic performance by cutting government deficits, rebalancing the policy mix (with lesser reliance on monetary tightening), and establishing conditions to heighten competition and boost job creation.

A key priority was to eliminate the federal government deficit of over 5 percentage points of GDP based on the following initiatives:

  • A retooling of the budget process to incorporate a transparent budget forecasting framework, including a contingency reserve for debt reduction.

  • An expenditure review of all federal ministries to refocus the role of the government and stress the cost effectiveness and efficiency of public services. A similar approach is guiding France’s recently launched review of public policy.

  • An ambitious state reform including notably a 20 percent cut in the federal civil service; a reduced presence of the government in the economy through selective privatization, and contracting out; and broad deregulation.

Steps to raise economic flexibility and competitiveness complemented the fiscal reforms. Key initiatives included reform of employment insurance and social assistance, pension reform, reduction of internal and external trade barriers, deregulation of major network industries, and cutback of administrative burdens.

The fiscal turnaround after 1994 was remarkable. The federal government outperformed its fiscal targets every single year thereafter and achieved fiscal surplus in 1998, a year earlier than planned. Expenditure cuts allowed federal spending to fall from near 17 percent of GDP in 1994 to about 12 percent in 1998. With the improvement of the fiscal situation, the government enacted one of the largest tax cuts in Canadian history in 2000

The improved macroeconomic framework based on sound fiscal, monetary, and structural policies created the conditions for sustained economic growth. Between 1997 and 2006, Canada enjoyed the highest job creation and output growth among G7 countries.

24. The authorities now aim for fiscal balance by 2012, a date they view as more realistic. They consider balance by 2010—as set out in the end–2006 Stability Program—possible only with appreciably higher growth (~3 percent). They viewed insistence on the same target date for all euro area countries as a conceptually flawed “one–size–fits–all” approach likely to fail in several euro area countries. Such an outcome was seen as more harmful to SGP credibility than France’s approach of a realistic 2012 target based on comprehensive tax and expenditure reviews (see below). Staff responded that the 2010 date per se was not the key issue; rather it was the failure to maintain a consistent adjustment pace and the repeated rescheduling of adjustment commitments that undermined credibility and increased the costs of adjustment (due to higher debt stocks and increased demographic pressure). Staff noted that any successful adjustment would require returning to a path of steady consolidation, achieved in the short–run by stricter spending targets; general pension reform in 2008, building on the reform of the special regimes underway; further healthcare reforms to expand co–payments and reduce underlying spending pressures; and strengthened commitments to restrain local government spending.

Fiscal reform

25. The government has launched a comprehensive review of public policy to secure better public services and lasting expenditure efficiency and reduction. Building on substantial efforts in recent years to improve fiscal governance and control expenditures (notably via the Organic Budget Law, LOLF), this broader review (RGPP) aims to go beyond marginal improvements in cost and efficiency to achieve a more fundamental improvement in public services and reduce spending as a share of GDP. A review of the extensive role of the state in the economy is key, refocusing on core missions and rationalizing the overlapping functions of multiple levels of local government. The planned merger of the tax and public accounting directorates (DGI and DGCP), modernizing tax administration structure, is a positive example of this rationalization. Finally, the review will serve to place public spending in a strategic framework, with a move to multiyear budgeting for the period 2009–11. Recently, the authorities unveiled the interim findings of the comprehensive audits underway, including some 100 streamlining measures. Staff strongly supported the exercise, noting the positive fruits that effective implementation yielded elsewhere (such as Australia, Canada, and Sweden), while cautioning against expectations of early results.

26. The government has also initiated a general review of the tax system. The review (RGPO) will allow the authorities to reevaluate the type of tax system needed to address the challenges of the globalized economy of the twenty–first century. The review’s objectives of greater stability, a supportive framework for business and investment, and greater use of environmental taxes should guide reform toward a more efficient system. Staff noted that the reform should give prominence to simplification and greater neutrality, producing a system with fewer distortions (deductions, exemptions, and tax credits, see Box 4). A key element should be a sharp reduction in tax expenditures, and the enshrining of the principle that all such tax decisions be taken only in the context of the budget (Loi des Finances). Until then, staff advocated a freeze on further tax expenditures, which are often taken off–budget cycle in response to sectoral pressures—a proposal viewed with favor by the budget authorities. The authorities, while noting the staff’s proposals, saw a tension in the call for stepped–up fiscal adjustment and its concomitant support for tax reform which, they noted, is seldom revenue–neutral.

D. Combining Financial Sector Stability and Efficiency

27. French banks remain sound and well–capitalized, though the recent financial turmoil has weighed on profitability and highlighted the importance of maintaining a strong capital base. Consolidated net income and return on equity of the eight main banking groups rose sharply and the ratio of nonperforming loans continued to decline in 2006 (Table 67). This solid performance continued in the first half of 2007 which, combined with strong capitalization, provided a cushion to absorb the impact of the crisis without jeopardizing solvency. However, growth came mostly from corporate and investment banking, asset management, and foreign markets, with expansion in domestic retail banking weaker. This slowdown in domestic retail earnings and increasing reliance on non–intermediation activities have increased banks’ balance–sheet vulnerability to heightened risk aversion and global liquidity retrenchment. Recent actions by some banks to consolidate off–balance sheet exposures, albeit generally not large, may also drive down banks’ earnings, as may rising risk in corporate credit. 16 In addition, the cooling–off in real estate prices, tightened mortgage lending, and expected sluggish demand raise the risk of a future downturn in the mortgage market.

Table 6.

France: The Core Set of Financial Soundness Indicators, 2000–06

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Sources: Banque de France, Commission Bancaire , BIS, and ECB.

These may be grouped in different peer groups based on control, business lines, or group structure.

All credit institutions’ aggregated data on a parent–company basis.

Consolidated data for the seven main banking groups (2005, IFRS).

Impact of the creation of the euro has to be taken into account.

Table 7.

France: Encouraged Financial Soundness Indicators, 2000–06

(In percent, unless otherwise indicated)

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Sources: Banque de France ; Commission Bancaire; BIS; and ECB.

In percent of financial firms’ gross operating surplus.

Data cover interbank and customer lending to residents and nonresidents on a metropolitan basis.