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August 22 - 28, 2012
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François Hollande’s Wrong Idea of France France’s new president, François Hollande, has achieved a remarkable series of political victories – at home and in Europe – since his election in May. Unfortunately, his streak of success will inevitably call forth an economic reckoning that will shock France’s apparently unsuspecting citizens and doom the French elite’s approach to the “construction of Europe.” Since winning the presidency, Hollande has won a parliamentary majority and pushed Germany toward accepting joint liability for eurozone countries’ debts. But forebodings of crisis have become widespread in French business and economic circles. But the real danger – which even Hollande’s sternest critics may be underestimating – is not so much his individual policy failings (serious though they may be) as his approach to the twin challenges posed by France’s economic imbalances and the eurozone crisis. On each front separately, he might manage to muddle through; together, they look likely to cement France’s loss of competitiveness. Declining competitiveness is best captured in a single indicator: unit labor costs, which measure the average cost of labor per unit of output. In a monetary union, discrepancies in wage growth relative to productivity gains – that is, unit labor costs – will result in a chronic accumulation of trade surpluses or deficits. Since the euro’s introduction, unit labor costs have risen dramatically faster in France than they have in Germany. According to Eurostat data published in April 2011, the hourly labor cost in France was €34.2, compared to €30.1 in Germany - and nearly 20% higher than the eurozone average of €27.6. France’s current-account deficit has risen to more than 2% of GDP, even as its economic growth has ground to a halt. The high cost of employing workers in France is due not so much to wages and benefits as it is to payroll taxes levied on employers. The entire French political class has long delighted in taxing labor to finance the country’s generous welfare provisions, thus avoiding excessively high taxation of individuals’ income and consumption – though that is about to come to an end as Hollande intends to slap a 75% tax on incomes above ?1 million. This is a version of the fallacy that taxing companies
(?capital?) spares ordinary people (?workers?). Of course, such taxes on firms are always passed on to households – usually through straightforward price hikes, and, in France, also through unemployment. High tax rates on labor – together with rigid regulation of hiring and firing – make employers extremely reluctant to recruit workers. As a result, France has had chronic long-term unemployment – forecast to reach 10.5% by 2013 – for many years. Hollande’s predecessor, Nicolas Sarkozy, tried to address this problem. He exempted voluntary overtime pay from employment tax and shifted some of the burden of labor taxation onto consumption (via a hike in VAT). But Hollande quickly reversed both of these reforms.
By BRIGITTE GRANVILLE Professor of International Economics and Economic Policy at Queen Mary, University of London, and the author of the forthcoming book Remembering Inflation
The repeal of the tax break on overtime reflects another economic fallacy to which French Socialist politicians are deeply attached: the “lump of labor” notion that underlay the most disastrous of their economic policies – the 35-hour workweek, introduced in 2000. The idea behind the policy is that demand for labor is a constant, and that this fixed number of aggregate working hours required by employers to meet final demand can be spread more evenly among workers to reduce unemployment. Such measures, designed to create jobs by freeing up work hours, are futile at best, and are often detrimental. French Socialists should recall their school physics lesson about communicating vessels: when a homogeneous liquid is poured into a set of connected containers, it settles at the same level in all of them, regardless of their shape and volume. Generating more “liquid” (jobs) requires not discouraging the entrepreneurs on whose activities sustainable job creation ultimately depends. The effect of fiscal and regulatory pressure on employment is to encourage French firms to
invest and hire outside France. Hollande’s apologists praise his gradualist and consensual approach to addressing the economy’s structural distortions. They argue that his penchant for setting up consultative commissions is the best way to forge the consensus required for structural reform, whereas Sarkozy’s combative style was counterproductive. Even banishing skepticism and assuming that Hollande could over time persuade his supporters to embrace competitiveness-boosting policies, the eurozone crisis is denying France the time that such gradualism requires. A simple, effective way to buy time would be to abandon the euro and restore competitiveness through a devalued national currency. But this expedient is incompatible with mainstream French politicians’ devotion to the “European project,” which amounts to a projection of French soft power; indeed, building Europe lies at the heart of the French establishment’s version of what Charles de Gaulle used to call “a certain idea of France.” For mainstream French politicians, renouncing the European project to buy the time required to restore competitiveness is as unthinkable as is the logical alternative: an allout push for full European political union. This would reestablish monetary sovereignty and create a normal central bank (like the Federal Reserve or the Bank of England) at the European level. But it would also mean abandoning France’s republic in favor of a federal European government – anathema to that “certain idea of France.” The combination of gradualism (on the most generous interpretation) in domestic economic reform and the paralyzing effect of the eurozone crisis will lead to a massive shock. Remaining in a currency union with the much more competitive German economy will require wrenching and rapid reforms, for which Hollande’s tepid approach will fail to prepare the complacent French. The result will be even more support than was seen in last April’s presidential election for extremist political parties that reject both Europe and competitive market capitalism. © Project Syndicate, 2012. www.project-syndicate.org
How Long for Low Rates? How long can today’s record-low, major-currency interest rates persist? Ten-year interest rates in the United States, the United Kingdom, and Germany have all been hovering around the once unthinkable 1.5% mark. In Japan, the ten-year rate has drifted to below 0.8%. Global investors are apparently willing to accept these extraordinarily low rates, even though they do not appear to compensate for expected inflation. Indeed, the rate on inflation-adjusted US Treasury bills (so-called “TIPS”) is now negative up to 15 years. Is this extraordinary situation stable? In the very near term, certainly; indeed, interest rates could still fall further. Over the longer term, however, this situation is definitely not stable. Three major factors underlie today’s low yields. First and foremost, there is the “global savings glut,” an idea popularized by current Federal Reserve Chairman Ben Bernanke in a 2005 speech. For various reasons, savers have become ascendant across many regions. In Germany and Japan, aging populations need to save for retirement. In China, the government holds safe bonds as a hedge against a future banking crisis and, of course, as a byproduct of efforts to stabilize the exchange rate. Similar motives dictate reserve accumulation in other emerging markets. Finally, oil exporters such as Saudi Arabia and the United Arab Emirates seek to set aside wealth during the boom years. Second, in their efforts to combat the financial crisis, the major central banks have all brought down very short-term policy interest rates to close to zero, with no clear exit in sight. In normal times, any effort by a central bank to take shortterm interest rates too low for too long will boomerang. Shortterm market interest rates will fall, but, as investors begin to recognize the ultimate inflationary consequences of very loose monetary policy, longer-term interest rates will rise. This has not yet happened, as central banks have been care-
ful to repeat their mantra of low long-term inflation. That has been sufficient to convince markets that any stimulus will be withdrawn before significant inflationary forces gather. But a third factor has become manifest recently. Investors are increasingly wary of a global financial meltdown, most likely emanating from Europe, but with the US fiscal cliff, political instability in the Middle East, and a slowdown in China all coming into play. Meltdown fears, even if remote, directly raise the premium that savers are willing to pay for bonds that they
By KENNETH ROGOFF Former chief economist of the IMF, Professor of Economics and Public Policy at Harvard University
perceive as the most reliable, much as the premium for gold rises. These same fears are also restraining business investment, which has remained muted, despite extremely low interest rates for many companies. It is the combination of all three of these factors that has created a “perfect storm” for super low interest rates. But how long can the storm last? Although highly unpredictable, it is easy to imagine how the process could be reversed. For starters, the same forces that led to an upward shift in the global savings curve will soon enough begin operating in the other direction. Japan, for example, is starting to experience a huge retirement bulge, implying a sharp reduction in savings as the elderly start to draw down lifetime reserves. Japan’s past predilection toward saving has long implied a large trade and current-account surplus, but now these surpluses are starting to swing the other way.
Germany will soon be in the same situation. Meanwhile, new energy-extraction technologies, combined with a softer trajectory for global growth, are having a marked impact on commodity prices, cutting deeply into the surpluses of commodity exporters from Argentina to Saudi Arabia. Second, many (if not necessarily all) central banks will eventually figure out how to generate higher inflation expectations. They will be driven to tolerate higher inflation as a means of forcing investors into real assets, to accelerate deleveraging, and as a mechanism for facilitating downward adjustment in real wages and home prices. It is nonsense to argue that central banks are impotent and completely unable to raise inflation expectations, no matter how hard they try. In the extreme, governments can appoint central bank leaders who have a long-standing record of stating a tolerance for moderate inflation – an exact parallel to the idea of appointing “conservative” central bankers as a means of combating high inflation. Third, eventually the clouds over Europe will be resolved, though I admit that this does not seem likely to happen anytime soon. Indeed, things will likely get worse before they get better, and it is not at all difficult to imagine a profound restructuring of the eurozone. Nevertheless, whichever direction the euro crisis takes, its ultimate resolution will end the extreme existential uncertainty that clouds the outlook today. Ultra-low interest rates may persist for some time. Certainly Japan’s rates have remained stable at an extraordinarily low level for a considerable period, at times falling further even as it seemed that they could only rise. But today’s low interestrate dynamic is not an entirely stable one. It could unwind remarkably quickly. © Project Syndicate, 2012. www.project-syndicate.org