Monetary and financial issues

Economic Survey of France 2009: Coping with recession and preserving fiscal sustainability

 

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The following OECD assessment and recommendations summarise chapter 1 of the Economic Survey of France published on 28 April 2009.

 

Contents

 

France is bound to experience a deep recession in 2009

Like other industrialised countries, France is facing the deepest economic recession of the post war period. After the severe contraction recorded in the last quarter of 2008, activity seems to have slowed further in early 2009. Yet with financial market turbulence a persistent threat and the risk of an even larger shrinkage in world trade, there is great uncertainty as to the timing and strength of the recovery. In any case, the decline in economic activity is likely to be very significant, even if less pronounced than elsewhere, with some likelihood of a gradual easing of the recession over the course of the year, supported by budgetary stimulus and interest rate reductions in France and abroad. The resulting job losses are set to drive the unemployment rate steadily higher throughout the year; at the same time, the inflation rate will probably approach zero.

But bank and household balance sheets are not as shaky as elsewhere

The financial system remains the primary source of major risks. Those risks will persist as long as there are doubts about bank balance sheets, and until the risk revaluation process reaches a stage where markets can regain the level of liquidity needed to function normally. French banks are, on the whole, in a somewhat better position than their counterparts in many other countries, primarily because they have diversified their activities and adopted more defensive prudential lending standards. This helps explain why household indebtedness has remained lower than in other countries heavily hit by the crisis. Moreover, the measures taken by the government in October 2008 to boost the liquidity and solvency of the big banks have allowed the bank credit market to keep on functioning, thus offsetting to some extent the drying up of the new issues market. In this regard, the recession may lead directly to further deterioration in banks’ assets, just at the time when their financial health is particularly vulnerable. The financial authorities will need to keep paying close attention to developments throughout the year.

The government is counting on investment to restart the economy

In this context, the authorities’ essential challenge is to keep the recession as short as possible without letting the public deficit and debt mount to unsustainable proportions. The economic stimulus package adopted at the beginning of the year – equivalent to 1½ per cent of GDP – largely respects these conditions, to the extent that most of the planned actions focus on investment and on business cash flow, and they involve bringing forward to 2009 expenditures that were previously to be spread over the next two or three years. Not only do they appear sustainable, but the actions taken to date seem fairly well targeted: they are aimed primarily at the productive apparatus and are designed, on the one hand, to relieve the liquidity constraints that suddenly confronted SMEs and, on the other, to speed investment in various infrastructure projects. At first glance, given the primary objective of shoring up the economy in the very short term, the choice of promoting infrastructure investment might appear questionable, in light of the long gestation periods associated with such investments and the risk of waste through haste. In practice, however, these drawbacks may not be as important as they seem: it is quite possible to favour programmes that have already been assessed in terms of their costs and benefits but that have been held up for want of financing. The government will need to take great care, however, to keep an eye on the expeditious and efficient implementation of the plan by ensuring the best possible co ordination among the players involved in distributing the additional resources. Since the deficit grew again already in 2007, at a time when the economy was still in a favourable cyclical position, the budgetary scope for dealing with the crisis is limited, especially as the public debt is nearly 70% of GDP. Nevertheless, if the recession proves to be more severe than expected, the government could consider additional measures, preferably transitory or automatically reversible (such as the temporary dispensations from income tax payments announced in February 2009) so as to safeguard the sustainability of the public finances.

Once recovery comes, priority must again be given to budgetary consolidation

Once the recovery is well underway, priority will have to be given to resolutely enforcing a general government deficit reduction plan, consistent with the obligations imposed by the Stability and Growth Pact and the government’s own objectives. Since publishing its Stability Programme at the end of 2008, the government has had to revise downwards the growth outlook for 2009 and 2010, and to revise upwards the projected deficits for those years, to 5.6 and 5.2% of GDP, respectively. A credible consolidation strategy will be all the more urgent, as the starting point will be a much larger imbalance than before the crisis, and pressures on the Social Security accounts will continue and could even intensify, given demographic trends. As in 1993, the recession will be accompanied by a jump in social transfers and, hence, in overall public expenditures, which in that year reached a historic high as a share of GDP (nearly 55%). While that proportion has declined somewhat in the meantime, it is still well above its 1990 level. That episode highlights the importance of steering away, as much as possible, from any supplementary measures involving expenditure increases that cannot be readily reversed as soon as the economy turns around.

The credibility of the budget process needs to be strengthened

Despite improvements to the budgetary framework contained in the 2001 Organic Law on Budgets, government expectations for reducing the public deficit have hardly ever been achieved, especially those set for two or more years out. Repeated commitments to restore budget balance have failed to bring the deficit below 2% of GDP since 2001. The budget framework was recently bolstered by Parliament’s adoption of a “balanced general government accounts objective” in conjunction with the new public budgeting act. In the light of these perpetual postponements of achieving the balanced budget goal, it seems necessary to take advantage of the implementation of this legislation to restore the credibility of the process as soon as possible. Unless this is done, efforts to win public acceptance of the need to clean up public finances will be undermined by an impression that any sacrifices are made in vain. One of the factors contributing to the discrepancy between budget deficit commitments and outcomes is the failure to achieve the short  and medium term growth rates assumed, even if these had been fairly close to the consensus view at the moment of their setting. To restore credibility, the authorities could consider an approach whereby their spending and revenue forecasts would be made deliberately and openly conservative for any given growth scenario, so as to maximise the probability that the objectives will be achieved, year after year.

A return to balanced budgets will require better control over spending

Many other countries will emerge from the crisis with heavy public deficits and rapidly mounting debt – France will not be alone in this regard. Yet, given the already very high tax burden in France, and the need to eventually lower it, the drive to restore health to the public finances will have to focus essentially on reducing outlays. While several other countries in the throes of budgetary problems have succeeded in reducing the expenditure to GDP ratio, the French ratio has increased steadily from cycle to cycle. Experience abroad shows that making meaningful spending cuts requires extensive rethinking of the role and the forms of State intervention in various fields. In this connection, the initiative taken with the General Policy Review (RGPP) deserves to be highlighted and encouraged, in particular for its highly methodical approach to evaluating government programmes and services and identifying reform tracks that would make public services more efficient. Nevertheless, the savings it has yielded to date seem modest indeed – less than 1% of public expenditure – especially since the RGPP was supposed to take a critical look at the boundaries of State action and the effectiveness of all its interventions. One reason for this is that the approach was confined primarily to central government outlays, which account for around one third of total public spending. Thus, there remains considerable potential for savings in fields that the RGPP has not fully explored, namely social security and local government spending.

The efficiency of local taxation should be enhanced and the structure of government rationalised

When it comes to sub national government, incentives to exert better control over expenditures could be reinforced by shedding greater light on the cost, in terms of taxes and compulsory contributions, of measures taken by each level of local government. To achieve this, it would be advisable to reverse the tendency of recent years and to fund a growing share of local government resources from local taxes rather than from State transfers. Over the longer term, however, the greatest potential for savings must probably be sought in the plethora of local government levels, which is a source of duplication in services and programmes. In particular, the establishment of the intercommunalités (groupings of municipalities) as an administrative level seems to have failed to produce the expected economies of scale in procurement and facilities management. On this point, the authorities would be well advised to follow up on the report of the commission that examined this question so as to clarify responsibilities and enhance expenditure control. As for the Social Security, to make really significant savings will surely require a critical reappraisal of certain benefits that have not demonstrated their effectiveness. Introduction of the new provision boosting incentives to seek work for those with low earnings potential (the Revenu de solidarité active, RSA) should have led to a greater refocusing of the existing provision (the earned income tax credit, prime pour l’emploi), whose effectiveness has been reduced by the fact that it is too broadly targeted. More generally, as called for by the new budgeting act, all tax exemptions and loopholes, which have mushroomed in recent years, should be subjected to a review similar to the RGPP.

 

Figure 1. General government public expenditure levels
As a percentage of GDP

Source: OECD, Economic Outlook database.

 

How to obtain this publication

 

The complete edition of the Economic Survey of France is available from:

The Policy Brief (pdf format) can be downloaded in English. It contains the OECD assessment and recommendations.

 

Additional information

For further information please contact the French Desk at the OECD Economics Department at eco.survey@oecd.org

The OECD Secretariat's report was prepared by Alain de Serres and Rafal Kierzenkowski under the supervision of Peter Jarrett. Research assistance was provided by Patrizio Sicari.

 

 

 

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