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Europe, France, Germany

3 reasons why the Socialists are right to revolt against PM Valls’ austerity plan

France’s ruling socialist party is in revolt. A very vocal minority don’t like the austerity plan of new PM Manuel Valls. And they are threatening to vote it down. Here’s 3 reasons why they are right

France’s new prime minister – now three weeks into his job – last week unveiled a swinging austerity plan. Although the mix of measures is different than previous policy announcements, it is essentially the same thrust of economic policy aimed at limiting public deficits to win ‘business competitiveness’ and restore purchasing power to households that has been pursued for a number of years. And they are not working. Economist Christian Chavagneux explains why

Reason #1. Too much austerity kills the possibility of reducing deficits.

France has for several years followed a deliberate policy of reducing its budget deficit. It was 7.9% of gross domestic product (GDP) in 2009 and 4.3% in 2013. This policy of controlling deficits and public debt may be necessary, according to EU rules, but it is very costly. According to the independent French Economic Observatory, the restrictive effect of fiscal austerity has reached a level not seen in at least forty years, including in the 1990s when France had to conform to the criteria of the EU’s Maastricht Treaty.

However, despite this historic effort, which will be extended to 2017 with 50 billion in savings, France is struggling to reduce its deficit: 4.8% of GDP in 2012, 4.3% in 2013, the reduction is slow. Why? Because France, like other countries, has underestimated the negative impact of austerity on growth. It seems that when we embark on a policy to cut the deficit by one point, we kill growth of more than one point. As a result, tax revenues fall faster than before and it is hard to reduce the deficit, which demands further austerity and makes it even harder to reduce the deficit.

The path of fiscal policy is traced to 2017: deficit reduction to control debt. But if we want to do it without killing the economy and employment, we must spread the effort over time. Finance minister Michel Sapin was quite right to go and negotiate an extension of the EU budgetary constraints in Berlin and Brussels. If France va mal, so does Europe, and the Commission as much as Germany have an interest in helping us out.

Especially since the financial markets believe in us: the French government is borrowing at very low interest rates and investors who want to hold igh quality debt have little alternative. The rates did not increase after the announcement by the President that he was going to seek an extension of the timescales for decifit reduction.

Once the limit is agreed and a commitment is made to deficit reduction, the a dely in the deadline of acheiving it is necessary, and if not Europe is only punitive. The important question is whether a period of one year would be enough to spread the pressure posed by austerity policies on economic and employment dynamics. That is not clear.

Countries that have managed to control their budget deficit by reducing public expenditure also enjoyed an accommodative monetary policy, and large devaluations. However, regards monetary policy, the European Central Bank (ECB) is stuck in a liquidity trap: it has, by its actions, controlled panic over public debt and lowed rates, but its ability [due to German opposition] to support economies is weak. Regards devaluation, the euro is appreciating, as the Single Currency area is attracting capital worldwide. Governments have attempted to gain competitiveness through internal devaluation, that is to say, lower labour costs. This is unfortunately not a good path to growth.

Reason #2. Internal devaluation does not produce growth

Lower social security contributions paid by firms is expected to help restore their competitiveness and enable them to gain share in export markets: overseas trade should help offset the effects of fiscal austerity at home.

However, this strategy has three contradictions.

First, lower social security contributions allows only a very slight decrease in production costs and provides little leeway to companies.

Second, the government’s willingness to quickly reverse the trend in unemployment has led it to favour reductions in contributions on low wages. This does not benefit the companies most intensely involved in global competition because in this market wage levels are reatively high. We may want to help the creation of low-skilled jobs, but this tool cannot also be used to boost the competitiveness of companies.

Finally, to be competitive, is to succeed in selling at high prices by virtue the quality of what is produced. Engaging in a race to pay the lowest bidder leads to wage dumping in other countries. Since many countries in the euro area have followed the same path of lower wages, we have seen producer prices decrease everywhere! Thus, no one wins: as economist Olivier Xerfi Passet has shown market share in export countries in the region have not changed. In contrast, wage deflation feeds deflation across the board, which increases the cost of debt in real terms (after inflation is deducted) and thus private investment.

Reason #3. Restore purchasing power to households: more spin than reality

At the announcement of the appointment of Manuel Valls, President Hollande said he intended to provide support to the purchasing power of households with a rapid decline of contributions paid by the employees. The idea is that companies will redivert the decline of employe social security contributions to net salary increases, thereby supporting the purchasing power.

A decision which unfortunately seems guided more by a concern for spin than economic efficiency. After announcing 30 billion social security contributions, it was necessary to show that households were not forgotten. And to communicate it the government have called the measure a “solidarity pact” – to be constrasted with the corporate ‘competitive pact.’

How much could this gift to households be? A priori, between 2 and 5 billion euros (against a 50 billion euros cut to public expenditure and 30 billion relief for businesses, excluding reforms of corporate taxes that are expected to be lowed). Indeed, it seems that the government wants to transform tax credits to the working poor into lower employee contributions, representing a budget a little more than 2 billion euros, to which would be added 2 – 3 billion euros more.

Such action raises two important issues. The first is that it deprives the welfare state of resources. What social security contribution would be reduced? It is unlikely that the government would take resouces away from the unemployment benefits fund or pensions. Would it remove the 0.75% contribution to health insurance, which is about 5 billion euros, at the risk of creating a hole in the social security system? Or will it cut the general social contribution tax (CSG), which funds healthcare? Whatever is decided, the result is a loss to the welfare state.

The second problem is that with an increase in their income, some employees will have to pay more taxes and lose some of the increase in purchasing power announced. Which means less money to sustain consumer demand.

We can only share Olivier Passet’s analysis, the French economy is now trapped in a triple lock of rigor: budgetary, with an unprecedented push to control public spending, monetary, with real interest rates increasing because of deflation, and wages, with purchasing power falling. The French President is right to seek fiscal leeway at a European level, but we don’t know what he’ll get. He made the wrong choice by seeking growth through lower labour costs, which both minimal in its effect, inefficient and a waste of public money. The new government is thus left relying on factors beyond its control: growth in other countries in the euro area and the rest of the world, the willingness and effectiveness of the ECB to avoid deflation, the will of the Germans and the Commission to help us get by.

Alternatives Economiques

About revoltingeurope

Writer on Europe's Left, trade union and social movements @tomgilltweets or @revoltingeurope

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2 thoughts on “3 reasons why the Socialists are right to revolt against PM Valls’ austerity plan

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