The Difficulty of Reforming France and Why Nicolas Sarkozy Doesn’t Get It

The current policy scene in France is most interesting. President Sarkozy was elected in May promising to introduce extensive reforms, putting the French back to work, and achieving GDP growth rate of more than 3% per annum (in real terms, I believe). But is Sarkozy’s plan going in the right direction?

A few months ago, I thought Sarkozy had good ideas but poor implementation knowledge. Now I am not sure anymore that he has good ideas. He may speak of policy reforms but for now he has tried to implement the wrong ideas in the wrong way. Let’s have a look at what he and his government have done in the first six months of his presidency.

Sarkozy has been extremely busy on the foreign policy front, which makes sense since foreign policy is the domain of the French President. He has helped in the liberation of hostages, has traveled to the US many times (including to talk to Congress), and has been to China and many other countries. The France-US relations are at their best in years.

As far as domestic policy is concerned, things are not so rosy. The election package contained a lot of promises for reform. The problem is that many of these promises are wrongheaded because they are not urgent. And what is urgent is barely discussed. In my view, France needs the following changes:

• A tax reform that would dramatically reduce the marginal tax rates for everyone, especially that of the most productive income classes. So introducing a top marginal tax rate below 30% for example would be start, with the goal of reducing it over time towards 20% (and less). Taxation on corporation should be aligned with personal income taxation so as to make the tax system as “neutral” as possible. Many taxes should be removed such as the tax on wealth.
• A labor code reform to make it easier to hire and fire people. This would include reductions in payroll taxation.
• A reduction of the government involvement in business. This entails continuing privatizing government-owned corporations in domains such as energy, transport, etc. It also means introducing competition in domains where it has been limited or absent, such as education (it also means increasing competition in health and other areas where the government is a heavy player). Last, it means removing (or at least reducing) subsidies to all, including farmers, in order to create a level playing field.
• A reduction in the size and scope of government, which includes a reduction in the number of government employees. This is in order to achieve the goals of (a) reducing the burden of public spending in the French economy and (b) reducing the size of the public debt. At the end of the day, we have no example of high-growth countries with high public spending.
• Pension reform to allow young people to escape the fate of an inverted age pyramid.

Any government in France who would take these five goals seriously would eventually succeed at turning the country around and help the economy grow beyond the stated goal of 3%. So in light of this, what have Sarkozy and his Prime Minister done so far?

Instead of going after an extensive tax reform, Sarkozy has proposed a tax cap at 50%, the de-taxation of extra working hours, exemption for mortgage interest rates, and more loopholes for inheritance. All this is better than what exists today but is not what is needed. This will make a marginal difference but will not create the conditions for huge productivity and labor supply increases. Moreover, Sarkozy has shown that he is willing to continue the old Colbertist approach to industrial policy. When certain groups (such as fishermen or farmers) claim to be in difficulty, they continue to receive subsidies from the government. Sarkozy has reacted the way all presidents in the last 70 years have reacted in France.

Instead of dedicating his time and energy to the deep reforms that are urgent (because they would have the biggest effect on total factor productivity and because they would benefit the entire population), Sarkozy and his government have chosen to mend what is perceived as a social injustice: special pension regimes for some employees in the public sector. While it is clear that the special regimes are a problem, Sarkozy knew that there would be some opposition to any change (and granted the reaction from the unions was more than expected). By focusing his energy on a small part of the population (they represent perhaps half a million people), he opened the door to direct confrontation with people who see themselves as the victims of the reform process. Instead, the reforms must be wide, fast, and affect the largest number of people. This makes it harder for any group to resist them, and also can be seen as fairer. For instance, if a tax reform benefits everyone (rich and poor), then it is harder for anyone to claim that the government is only giving a present to its rich friends.

The result of the mess in the last three weeks is that Sarkozy has destroyed some important reform capital. While the majority of the population is against the strikes, it now believes that reforming is going to be more challenging than expected. It also makes people believe that all that is needed is to redress inequities in the pension system (and other related issues), rather than the deeper changes in tax and labor laws. All this is going to make the urgent reforms more difficult to carry out.

Everything is not lost. For 20 years governments in France and other EU countries have been reforming via the back door. Privatizations have taken place including (and especially) under socialist governments. This can be seen in France’s ranking in the World Bank Doing Business index for instance, which has improved (although France's ranking in the Economic Freedom of the World Report has not). However, marginal reforms mostly achieve one thing: avoiding the abyss. They keep the country more or less on life-support but do not steer the economy towards the high-growth lane.

As of now, the main thing that can save France and Western Europe in the long run is the success of some Eastern European countries, such as Estonia. In many transitioning economies, a flat tax has been adopted and regulation has been reduced. The impact on growth is already very noticeable. Unless EU rules destroy those pockets of free enterprise, their success will be such that they will become an example of what should be done in Old Europe. But considering how long it takes for income per capita to grow (even when the economy grows a more than 7% per annum), this effect may take another 25 years or more.

Comments

[Sleeper]

Very interesting, thanks for posting this.

[Rafe Champion]

They could learn something from the New Zealand experience of "Rogernomics" where the idea was to move quickly on a broad front so that people who were losers from some changes would gain from others and there was no sense of any particular group being picked on (well in theory anyway). You would know all about that Fred!