According to the French writer Rabelais debt and deceipt are almost invariably inextricably linked. So it is appropriate that it should be a French banker – Michel PÃ©bereau – who takes it upon himself to try to bring this harsh reality home to a French public which still seems excessively steeped in the finer details of the arts of self-deception. PÃ©bereau does not mince words: over a quarter of a century century French public policy has accumulated for itself a national debt has neither supported economic growth nor reduced unemployment. The debt is “asphyxiating” and unless the State acts to reduce its spending now France will â€œlose control of the financial situationâ€ before the end of the decade. Indeed so stark is the picture PÃ©bereau paints that French economy minister Thierry Breton, on reading the report, was moved to comment: â€œUnbeknownst to them, our children are already financing part of our standard of living.â€
The details of the report are however just as intriguing as the headline-grabbing quotes. According to Morgan Stanley’s Eric Chaney:
1. Including pension and other liabilities, the general government debt is worth between 90% and 96% of GDP and its dynamic is not sustainable: it is currently increasing significantly faster than GDP.
2. Raising taxes to reduce the deficit and curb the debt is not an option because it would harm economic growth.
3. Freezing central government nominal spending would deliver a balanced budget within five years.
In fact France’s current debt is expected to reach 1.17 trillion euros by the end of the year, about 66% of France’s national output. However the report also warns that France has “off-balance sheet” public pension liabilities of anything up to an additional one trillion euros – and it is this that takes the estimates of the state’s total liabilities to somewhere in the region of 100% of GDP. These liabilities are unfunded, and exist because in 2010 expenditure will exceed income in the pension system. It is this realisation perhaps more than anything else which produced Breton’s wry comment.
Even more alarming has been the rate of growth of the French public debt, which – excluding pension liabilities – rose from 35% to 66% of GDP between 1990 and 2005, or at a rate which has been almost two percentage points above the gross wealth created every year in France. And this has been during the ‘good times’ demographically speaking.
Eric Chaney continues:
“The question is not whether reforms are necessary but what kind of reforms. In this regard, I believe that the shock therapy option is neither politically feasible not effective, at least in a fixed exchange rate regime. In theory, if tax payers anticipate that rebalancing government books should prevent tax rates to rise in the future, they should react to higher government savings by drawing on their own savings â€” behavior often named Ricardian equivalence. However, as I have shown in a previous note, a full Ricardian equivalence is unlikely in large and relatively closed economies (see The Arithmetic and Politics of Fiscal Policies, Eric Chaney, September 3, 2002). This option was nevertheless chosen by the German coalition, for 2007, which is leading us to anticipate a sharp slowdown in GDP growth that year. Instead, the PÃ©bereau report is calling for a gradual treatment which would bring the government books back to balance in five years.”
Here two things are worthy of note. Firstly, the recommended course of action will balance the books (not start to reduce the debt) in five years time. Secondly, Germany has gone for much stronger medicine.
Whatever the final course of action adopted in France one distinct possibility lies out there in the near future – that 2007 will be the year in which three of the big four European economies (France, Germany and Italy) all start to introduce major fiscal tightening simultaneously. The impact of this on Eurozone growth is not in doubt – it will be severely negative – the only real doubt is just how severe is severe. So while the point has often been made that the cost of not maintaining the Stability and Growth Pact may be extracted by the financial markets, I think we might also now begin to contemplate another possibility: that the cost of not adhering to the pact will be several years of extremely, and I do mean extremely, lacklustre growth.