France downgraded, trouble looming

[admin]

Luckily we have Evans-Pritchard..

---

France’s 'AA' Hollande pays price for kowtowing to EMU deflation madness

By Ambrose Evans-Pritchard Economics Last updated: November 8th, 2013

Comment on this Comment on this article

Standard & Poor’s downgrade of France to AA is an indictment of Euroland’s entire contraction regime.

Yes, S&P says France has bottled it on reforms. Francois Hollande’s patchwork of measures – losing momentum anyway since early 2013 – will not be enough to pull the country out of sclerosis.

• Tim Stanley: Obama says ‘sorry’. Miracles can happen
• Tom Chivers: Twitter and Silicon Valley: in a world of their own
• David Blair: Are our spymasters coming out of the shadows?

It warns too that France is on borrowed time with a state sector over 56pc of GDP, now higher than Sweden, but without Swedish labour flexibility and free enterprise. We all know this.

But the deeper critique is that France has been set an impossible task.

1) Perma-slump is playing havoc with public finances, causing the budget deficit to stay above 4pc of GDP. “We believe lower economic growth is constraining the government’s ability to consolidate public finances,” it said.

France’s heroic fiscal squeeze of 1.8pc of GDP last year – in order to comply with EMU demands – was at best self-defeating, and arguably destructive. All France got was a double-dip recession. Some 370,000 people have lost their jobs. There is a proper therapeutic dose of fiscal austerity, and it should always be offset by monetary stimulus. Both rules were violated.

As S&P says, Hollande made matters worse by relying on taxes, not spending cuts. You don’t have to believe in the Laffer Curve to see that a country with a Leviathan state should not keep raising the tax share of GDP.

2) You cannot carry out deep reforms in a deep downturn. “Ongoing high unemployment is weakening support for further significant fiscal and structural policy measures,” it said.

This is the nub of the matter. The central tenet of EMU doctrine is that countries will not reform unless they face a crisis, and their feet are held to the fire. There is a near religious belief in Berlin – evangelised by Brussels, and the EMU gang of five – that any let up in austerity, any recourse to stimulus, let alone a new deal, is a gift to shirkers who want to dodge reform.

It is an elemental misjudgement. Yes, there may be small countries where this applies. They can hope to export their way out of trouble, if they have a high enough trade gearing. They may be able to overcome the debt deflation shock if their debt levels are low enough. If not, they can go to the IMF for a package of reform cushioned by debt relief, devaluation, and cheap IMF bridging loans.

None of this applies in southern Europe or to the quasi-EMU states in trouble in central Europe and the Balkans. If a region holding 300 million people tries to retrench at once, it causes a self-feeding downward slide for the whole system. That is exactly what we are seeing.

Euroland is relying on exports to the rest of the world, but that means it now has a huge trade surplus and risks becoming a trade violator. This will not be tolerated for long. The US Treasury’s warning shot last week is just the start of a nasty fight.

Besides, France, Italy, and Spain, are too big to be pushed around for ever. They have other options. They can fight back in all kinds of ways. It is inevitable that they will do so.

For Francois Hollande, it is a nightmare coming true. He asked to be judged on his success in “bending the curve of unemployment”, and judged he will be.

There is no recovery worth the name in sight. Industrial production fell 0.7pc in September, the fourth decline in five months. Annalisa Piazza from Newedge Strategy says there is now a risk that the French economy will contract again in Q3. That would be political dynamite.

Hollande campaigned in 2012 on a growth ticket. He dabbled briefly with a Latin Bloc alliance to force a change in EMU policy, but hid behind Italy’s Mario Monti (who tried to calibrate it), and never took the lead. It was doomed to failure.

Instead, Hollande lamely buckled to EMU-core demands, and split the French Left by going along with Angela Merkel’s catastrophic Fiscal Compact. This treaty is an infernal deflationary machine for 20 years to come, the ultimate culmination of German folly. Hollande was told by an army of French economists – including the excellent Observatoire, on the Left – that this would lead to depression and deflation, as it has.

Without wishing to cause too much offence, he risks becoming the Pierre Laval of 1935, the executor of deflation decrees that he does not really understand, the pacificist idealist (yes, Laval was, once) who lost his way trying to enforce the mad logic of the 1930s Gold Standard, the EMU of its day. (Laval lost his way further under Vichy, but that is another story).

It is not too late for Hollande to avoid this horrible political fate. He can at any time pluck up courage, forge a grand reflation coalition, and bring Brussels to heel. He is the elected leader of a great nation. EU officials are just civil servants.

This means confronting Germany, of course. But that fight has to come, as Paris Professor Steve Ohana lays out in his new book “Désobéir pour sauver l’Europe”. France must revolt to save Europe, and only France can lead such a coalition.

Let me be clear. The quarrel is not with the German nation, but with the 1930s policies being enforced on Europe by Angela Merkel and German political establishment. (Have they all forgotten – or never learned – that it was the Bruning deflation of 1930-1932 that destroyed Weimar?)

We can all agree that Germany has been a magnificent example to the world for sixty years. It is a thriving democracy under the rule of law. It has a constitutional court that really does defend liberty. Germany did not aspire to the hegemony it now has, and does not want to keep it. That is the strategic tragedy of EMU.

There is a near consensus view that Chancellor Merkel is an outstanding leader. I think this reflects a psychological defect in the press and the commentariat. We cleave to power. We adore it. We flatter it.

So me let dissent, since power is not my cup of tea. I think that current German policy across a wide range of economic and foreign policy issues (Libya, Mali, Syria, Russia) are destructive and potentially dangerous, especially for Germany in the end. Angela Merkel has her qualities but she is a very poor leader indeed. History will judge.

[admin]

Krugman isn't too impressed

---

Ideological Ratings

So S&P has downgraded France. What does this tell us?

The answer is, not much about France. It can’t be overemphasized that the rating agencies have no, repeat no, special information about national solvency — especially for big countries like France. Does S&P have inside knowledge of the state of French finances? No. Does it have a better macroeconomic model than, say, the IMF — or for that matter just about any one of the men and women sitting in this IMF conference room with me? You have to be kidding.

So what’s this about? I think it’s useful to compare IMF projections for France with those for another country that has been getting nice words from the raters lately, the UK. The charts below are from the WEO database — real numbers through 2012, IMF projections up to 2018.

First, real GDP per capita:

So France has done better than the UK so far, and the IMF expects that advantage to persist.

Next, debt relative to GDP:

France is slightly less indebted, and the IMF expects this difference to widen a bit.

So why is France getting downgraded? Because, S&P says, it hasn’t carried out the reforms that will enhance its medium-term growth prospects. What does that mean?

OK, another dirty little secret. What do we know — really know — about which economic reforms will generate growth, and how much growth they’ll generate? The answer is, not much! People at places like the European Commission talk with great confidence about structural reform and the wonderful things it does, but there’s very little clear evidence to support that confidence. Does anyone really know that Hollande’s policies will mean growth that is x.x percent — or more likely, 0.x percent — slower than it would be if Olli Rehn were put in control? No.

So, again, where is this coming from?

I’m sorry, but I think that when S&P complains about lack of reform, it’s actually complaining that Hollande is raising, not cutting taxes on the wealthy, and in general isn’t free-market enough to satisfy the Davos set. Remember that a couple of months ago Olli Rehn dismissed France’s fiscal restraint — which has actually been exemplary — because the French, unacceptably, are raising taxes rather than slashing the safety net.

So just as the austerity drive isn’t really about fiscal responsibility, the push for “structural reform” isn’t really about growth; in both cases, it’s mainly about dismantling the welfare state.

S&P may not be participating in this game in a fully conscious way; when you move in those circles, things that in fact nobody knows become part of what everyone knows. But don’t take this downgrade as a demonstration that something is really rotten in the state of France. It’s much more about ideology than about defensible economic analysis.

[admin]

More from Krugman on France and I have to say, it doesn't look nearly as bad as I thought. On the other hand, it doesn't look good either..

 

---

More Notes On France-Bashing

First things first: France has problems. Unemployment is high, especially among young people, many small businesses are struggling, the population is aging (although not nearly as much as in many other countries, Germany very much included.)

By just about any measure I can find, however, France looks not too bad by European standards. GDP has recovered roughly to pre-crisis levels; the budget deficit is fairly small and the medium-term debt outlook not at all scary; the long-term budget outlook is actually pretty good compared with its neighbors, thanks to a higher birth rate.

Yet the country is the subject of vituperative, over-the-top commentary. Here’s The Economist, a year ago, declaring France “The time bomb at the heart of Europe”. Here’s CNN declaring that France is in “free fall”.

That CNN piece actually offers a few specifics. It argues that France faces a “yawning competitiveness gap” due to rising labor costs. Hmm. Here’s what I get from European Commission numbers, comparing France with the euro area as a whole:

European Commission

There’s a bit of deterioration there, I guess — but it’s more yawn-inspiring than yawning.

CNN also declares,

France’s decline is best illustrated by the rapid deterioration in its foreign trade. In 1999, France sold around 7% of the world’s exports. Today, the figure is just over 3%, and falling fast.

Hmm.Just about every advanced country, the United States very much included, has a declining share of world exports (Germany is an exception); this New York Fed research paper notes that this decline is more or less in line with the declining share of advanced economies in world GDP as emerging nations rise, and it portrays France as more or less typical.

Again, the point is not that France is problem-free; the question is why this only moderately troubled nation attracts rating downgrades and so much apocalyptic rhetoric.

And the answer just has to be politics. France’s sin isn’t excessive debt, especially poor growth, lousy productivity (it has more or less matched Germany since 2000), poor job growth (ditto), or anything like that. Its sin is that of balancing its budget by raising taxes instead of slashing benefits. There’s no evidence that this is a disastrous policy — and in fact bond markets don’t seem concerned — but who needs evidence?