Growth in France is set to come to 1.8% in 2017 and 1.7% in 2018. From today’s standpoint, these figures look high as trend growth for the French economy came to slightly more than 1.1% on a yearly basis between 2013 and the third quarter of 2017, making 2017 and 2018 look like good vintages. However, a comparison with the pre-crisis period is harsh. Trend growth for the French economy stood at 1.8% over the period between 2000 and 2008 and could go well beyond this figure, which equates to the cycle peak in today’s economy.
The extent of the economic cycle provided leeway for all concerned as growth could go well beyond this trend, e.g. coming out at 4% in 2000. French economic policy at the time did not generally view this cycle peak as an opportunity to adopt a more restrictive strategy, and France as a whole was unable to reduce imbalances when growth was strong, particularly from a budgetary standpoint. The French budget “funding pot” concept, invented during periods of vigorous growth, was used to justify all sorts of spending on the back of higher budget revenues.
Today’s growth statistics are much lower and do not provide the same degree of flexibility that was once available, so economic policy must be addressed differently to take on board this more limited pace of growth.
This leads to two effects:
1- economic policy needs to take advantage of periods of growth to regain leeway, rather than using this usually short-lasting situation to embark on spending measures that cannot be financed in the long term. Adopting lax fiscal policy is usually not very effective as spending undertaken at the cycle peak merely looks like comfort spending.
2- this is not a rejection of the Keynesian economic approach. Keynes only advocated an extension of public intervention when it was used to offset insufficient private sector demand, and this is generally not the case at the cycle peak. However, this spending is planned and made with a long-term view and still has to be dealt with when the cycle takes a dip.
The sometimes clumsy discussions from the French government on spending choices are a result of this logic. We are now at the cycle peak and this is the time to make choices to reduce comfort spending. This situation obviously raises concerns and demands, but it is vital if we are to avoid further aggravating the budget imbalance in the future. We are at the peak of the cycle and it is vital to regain flexibility by making changes now.
Recovery triggered tensions
However, criticism is easy in light of sluggish growth. It is tempting to say that these budget restrictions dent growth and that a more aggressive fiscal policy would expand the boundaries and push the economy towards higher figures than those mentioned above.
This kind of strategy was right two or three years ago or even recently, but not any longer. The recovery led to tensions on production, and the production capacity utilization rate for industry has increased significantly over recent months, pointing to a physical limitation on growth. The third quarter figures are higher than the average over 1995-2007, when the economy was performing well. Similarly, companies are not managing to recruit as they would like. This pressure on the economy, which reflects stronger internal momentum, can also be seen on the very strong uptrend on imports.
Seeking to move beyond these tensions very swiftly means taking the risk that the French economy would overheat, and this is where we see that the French economy was hard hit by the crisis and the policies implemented at the time. The period starting after 2010 was very tough for the French economy and has led to a hefty lag at this stage as compared to the past.
It is not the end of the world but it is obvious that the French economy is currently unable to grow any faster. Increasing demand via economic policy is sometimes recommended, but this would not lead to an acceleration in growth but rather an overheated economy.
Streamline public finances, while maintaining economic constraints
In the absence of intervention from economic policy, current cycle peak figures would be followed by a return to the long-term trend and potential growth of around 1.2%, with convergence poised to start in 2019. Economic policy must therefore be used to take action and trigger fresh impetus that will drive up this sluggish trend and set it on a stronger trend.
Decrees on the labor market may not be perfect and will only be effective if they include training to round them out, but the market as it stands does not look capable of setting the economy onto this stronger trend. Similarly, efforts on public spending are pointing in the same direction by creating incentives to invest further in the private sector, innovate more and thereby fuel more robust momentum.
The French economy needs to be rebuilt as it is not as strong as in the past. This requires a different approach to economic policy by taking on board the current position at the cycle peak. It is right now, as 2018 approaches, that public finances must get their house in order while implementing an economic policy aimed at taking the shackles off production and the labor market. Moves by the government are a step in this direction. Demand has now improved on the back of job creation and ensuing sounder revenue momentum.
We now need to ease restrictions on supply while ensuring that current budget imbalances do not worsen further. This is quite a challenge, but it is feasible in the long term.
This is my weekly column for Forbes. You can find the original French version here